Volatility can be Your Friend
08/31/07
Volatility: Some use it as a euphemism for declining stock prices. Some use it to define unpredictability and others use it just as an excuse for bad performance. No matter how the word "Volatility" is used, it always conveys something bad, lurking out there, hidden in the dark, subconscious recesses of our minds. Never, however is it used in a positive context. What a shame. Volatility can be an investor's friend and a trader's answer to all his prayers. Just consider this: During the month of August the S&P 500 traveled from each day's high to each day's low more than 500 points. That is 35% of the current index value of 1470 and makes August 2007 the most volatile month in many years. Is volatility really that bad? Only if you are not prepared for it! How do you invest in it? You don't. You trade it. That's what it's there for. It serves traders. Not investors. You buy the hard sell-offs and you sell rallies that end near resistance. You don't look at fundamentals, you don't invest for the long term, you just trade for tomorrow. Traders don't look for a fundamental value or long term developments; they look to rent stocks, not own them. Traders in many cases don't care what company they use in order to profit from volatility. They are simply looking for tools that allow them to ride the wave, that's right – traders are volatility surfers.
So much noise, so many headlines and the stock markets ends the month higher tan it started. August -- for all its scary gyrations and threats of financial Armageddon -- finished with the Dow up 1.1% and within 5% of its all-time record high of 14,000. Barron's Michael Santoli wrote in this week's edition:
"With it all, though, it remains striking that as small investors steer clear of stocks and much of the financial press has taken on a scolding, sometimes mocking tone toward Wall Street, corporate insiders have been buying more stock relative to their sales than at almost any other time. The ratio of insider selling to buying has been below 10 for nine weeks, a rarity. And TrimTabs last week noted that insiders were net buyers of shares on six separate days this year, and four of them were since Aug. 16. Meantime, money-market fund inflows have surged and the American Association of Individual Investors survey Thursday showed bears outnumbering bulls for a fourth straight week."
That about sums it up. Public sentiment is too negative, while insiders are buying with conviction. This does not mean, however, that the direction for the month of September is up. All that insiders are telling us is that they see value in their particular stocks. After all, the market is a voting machine in the short run and a weighing machine in the long run. It may therefore be a couple of months before the markets get around to challenging the old highs. What the insider buying does confirm, though, is my sense that the US stock market is not headed for a crash since it is one of the most inexpensive markets worldwide.
Many of the biggest stock investors have reached the same conclusion. A growing number are starting to sell puts on stocks they've been watching and considering buying in coming months. These investors are taking advantage of elevated put prices and are positioning to buy favored stocks should the shares decline below the put strike prices. Thus, selling put options gives the investor immediate income from the sales proceeds of the options while at the same time forcing him to keep ready cash in the account just incase the option is exercised and he is forced to buy the stock. Thus selling puts is a great disciplinarian, which might safe many investors from themselves these days, because let's be honest: It does not make much sense that stocks surge one day and drop the next (or vice versa) with little new information other than a rumor of bankruptcy here and a rumor of a takeover there. "The fundamental backdrop is sound" we are being told by Hank Paulson and other officials and the market believes it and surges by a percent or two. Then we hear Robert Toll pronounce that the environment for homebuilders "sucks" and the market wakes up the morning after and realizes: "What was I thinking?" Manic depressive environments are the stuff traders are thriving in and investors are not, so they say. I disagree. As an investor, you just have to adapt and get used to trimming your positions after several up days and buying after several down days. This of course requires agility and the conviction that we have not entered a bear market. If you believe that this economy is headed for a recession then we must have entered a bear market and all bets are off and you are better off staying in cash. As traders, we don't care which way the economy is going because we are used to hitting the buy and sell button on a regular basis anyway. Let's ride the wave until this market tells us which way it wants to go.
Hermann Vohs
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
