Protect Your Portfolio From the Fed

Image for the Fed is about to rattle the markets

“Everybody has a plan until they get punched in the mouth.”

This quote, one of former heavyweight champion Mike Tyson’s most famous, is always relevant when investing.

After countless hours of research, diversifying portfolios and strategies, investors feel confident about weathering a market storm — until they are punched in the mouth.

Today, we are going to take action, making that proverbial punch a nonfactor…

Last week, I explained how I expect stocks to be in for a short-lived rally that you want to ride higher. I still believe that will be the case.

But, in the middle of this week, the Federal Reserve ends a two-day meeting that has the possibility of creating turbulence in the market. You don’t have to step into this ring unprepared; I have a trade to protect your portfolio against a possible punch, even if it’s from Mike Tyson.

To do this, we are going to use iPath S&P 500 VIX Short-Term ETN (NYSEarca: VXX). I will give you all the trade details in a minute, but first let me explain why the trade makes sense this week.

Fed Watch

On Wednesday, the Federal Reserve will release a statement around 2 p.m. EDT. I am not expecting any radical changes, but neither is anyone else — which leaves plenty of room for the Fed to stir up the markets.

The reality is that the Fed is coming increasingly close to the end of the year — a time Janet Yellen continues to emphasize as a time frame for the initial rate hike.

That means the Fed needs to begin changing the language in its press releases from dovish to hawkish, signaling an imminent rate hike. And those changes could begin as early as this meeting.

With no press conference to follow this meeting, Janet Yellen will not get to reiterate her dovish stance if Fed watchers take the press release as hawkish — it will be left up to market participants to decipher her tone.

Personally, I don’t see the Fed raising rates this year. After doing countless hours of research, a rate hike just doesn’t make sense for the Fed yet. And when the Fed does raise rates, it won’t be considered much of a hike.

But if Yellen sticks to her guns of raising rates this year, she is running out of time. The day of that initial hike is getting closer and closer each month.

And that may be a punch in the mouth when it happens, changing most investors’ plans. Today’s trade is protection from that.

Capture Gains on a Pop in Volatility

As you will notice, we are using a CBOE Volatility Index (VIX) exchange-traded note (ETN). The VIX is also known as the fear index — traders use it to gauge the level of fear in the market. The current low reading in the VIX is showing that investors are not anticipating the Fed to make any changes this week. But without a press conference, the statement will be left up to Fed watchers to debate what it really means.

This could easily spark some fear in the markets, causing investors to pay more for protection, which will send the VIX higher.

Since we are using the ETN, the price of the underlying value continually decays. That’s why I want you to close this position no later than the close of business on Friday.

Action to take: Buy to open the VXX August 21, 2015 $16 call option (VXX150821C00016000) at market. At last glance, it was trading around $1.92.

Remember, this is an extremely short-term opportunity that protects your portfolio from a desperate Fed that may begin to prepare markets for a rate hike later this year. For long-term protection, you can add protection to existing positions, or grab puts on the S&P 500. And because volatility is relatively low right now, you can purchase this protection cheap — I used inexpensive puts to protect a long stock position in Pure Income last week.

But with this trade, all we need is a small pop in volatility to see the option generate triple-digit returns as it did during this same week a year ago.

Either way, this trade protects your portfolio from a possible Mike Tyson right uppercut.

Also, stay tuned for Jeff Opdyke’s special video announcement on Tuesday, where he reveals how he uncovered “invisible stock patterns” that have enabled him to lock in triple-digit gains on trades.

Chad Shoop Sovereign Investor
Chad Shoop
Editor, Pure Income