WEEKLY MARKET UPDATE

The long term trend remains up.  This week the market closed higher than the previous week so the intermediate term trend is pointing back up.  Last week I said that if there was a strong weekly higher close I would be more convicted that the high made in May (upper green line) would be retested.  Although we got a higher close, it was not a particularly bullish close.  However, it was a shorter week due to the holiday.  The lower green lines remain strong support and the upper green line strong resistance.  Based on recent price action I think that there is a strong likelihood that we may just see the market bounce around between these levels.  But for now, both trends are pointing up.

HEDGING

As I stated last week the primary objection to hedging is the cost.  I also went on to say that over the long run an investor who prudently hedges will come out ahead.  So what does prudently hedge mean?  Simply, you want to keep the cost of hedging as low as possible so you can enjoy similar returns to the investor who does not hedge when the market is rallying strongly while at the same time strictly defining your risk when the major market correction does come.  My model or blueprint of how to do this is as follows:

1)    When an intermediate term buy signal is given I begin selling covered calls against the underlying.  Each month I will sell calls above the current price of the market.  I choose a strike price at about a 30 delta.  I will sell calls at about a 50% ratio to the stock.  What this means is if I own 200 shares of the SPY I begin selling calls.  I will sell only one SPY call (equivalent of 100 shares of SPY).  The primary objective is to accumulate cash in my account to either largely reduce or in some cases entire pay for the cost to hedge when that time comes.

2)    Hedge only when you need to.  I use an intermediate term timing model/system to help me do this.  I typically would buy ¼ to ½ the number of puts I need when the model/system tells me that the market has moved too far in an up trend and is likely to have a larger than normal correction.  I buy the other ½ - ¾  when an intermediate term sell signal is given.

CONCLUSION

I should point out that selling calls as described above is only workable outside of a 401-K.  If most of your funds are in a 401-K, you wouldn’t be able to enjoy the benefit of using call premium to pay for your hedge.  But you would still keep the cost of hedging low by using a good intermediate term timing model/system to tell you the optimum time to put on the hedge.