WEEKLY MARKET UPDATE

The long term trend remains up.  However, as I've pointed out in my last two posts, a high probability exists for an intermediate term correction, especially after last week's price action (see SPY chart).  As you can see the market opened higher than the previous week only to close lower than where it closed the previous week.  This is very bearish price action. If the SPY next week closes below 162 the probabilities are very high that the market will correct at minimum to the 157.50 (lower green line) which represents the previous all time high made in the SPY in October, 2007.  If the market continues to correct below that level, a test of the 40 week moving average (white line) currently at 150.72 is likely.

This market is long in the tooth and overdue for at least an intermediate term correction.  As I mentioned last week, If you have been long from a much lower levels it may be wise to take some profits off the table or look at potentially hedging by buying put options.

HEDGING

In last week's post I illustrated a simple yet powerful hedge technique which involved buying simple put options to hedge a portfolio with stocks, ETF's or mutual funds.  Many of you may be thinking great, but I have the following questions:

1)  What kind of puts do I buy to provide an adequate hedge?  ANSWER:  The puts should be related to an ETF which is most closely related to your portfolio.  If your portfolio is most heavily weighted with blue chip companies, consider buying put options on the DIA.  If mostly technology stocks, consider the QQQQ.  If mostly large cap stocks, then consider the SPY.

2)  How many puts do I buy to provide an adequate hedge?  ANSWER:  The formula for determining how many puts to buy is simple.  You simply take the value of your portfolio divided by (the current ETF price X 100).  As an example, let's say today your portfolio value is $100,000 and it is most closely correlated to the SPY.  Friday's SPY close was 163.18.  Following is the calculation for the number of puts you need:

$100,000 divided by (163.18 X 100) = 6.12....or 6 SPY puts.

CONCLUSION:  Next week I'll get more into what strike price one may consider purchasing as well as how much time to buy.  In future posts I'll talk more about when one may consider putting on and taking off a hedge as well as ways to lower the costs of hedging.