Stay Invested During Volatile Times

Stay Invested During Volatile Times
by Ken Trester 09/18/08

Even when the near-term investment horizon looks clear and even bright, many investors remember when they got burned by more than just the sun in the days, weeks, months or even years prior. And that's because several formerly scorching-hot stocks oftentimes need more than a coat of aloe to heal the blisters they acquired (and inflicted on their shareholders) in the process.

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Market collapses are about good stocks -- although investors tend to go to cash when the market activity gets hectic, it would serve them well to do a little research on the companies that hold up well and that are poised to go even higher when the markets regain their stability.

But yet, sometimes the best-run companies and the strongest stocks get taken to task during a panic period. And there's nothing wrong with buying some put options on even the best companies when they're going down -- options are not a permanent bet.

That's the beauty of trading options -- they allow you to capitalize on the near-term direction of a stock. Even if you're absolutely certain that a stock price would be going up under "normal" trading conditions, there's nothing wrong with making some quick profits if it unexpectedly finds itself traveling in the "wrong" direction.

Case in point: We had a Sony (SNE) put option position on the table. The option value shot up more than 70% in fewer than five trading days simply because the stock cratered.

We initiated the position while the markets were being rattled as the credit crunch that started in mid-2007 started spreading. Not only were the housing and lending stocks getting kneecapped, but the venom was spilling into other sectors that had nothing to do with buying or building homes.

So, what did Sony have to do with the credit crunch that was brought on by the subprime-lending fiasco? Theoretically, nothing. But, like many other good companies, Sony became an innocent victim of the market. But instead of being innocent bystanders, we were able to jump in and make some happy returns as the share price took a surprising tumble.

I've found that many traders can be hesitant to establish bearish plays in general, and especially not on companies whose long-term prospects they believe in. If this is a challenge you face, I encourage you to banish this mindset because your No. 1 goal is to profit. And one of the fastest and most-effective ways to do so is through buying put options on stocks that are going down.

Sure, no method is foolproof, but buying a mix of bullish (calls) and bearish (puts) options can serve to ensure that you are making money without having to predict the overall market direction.