Use Market Volatility To Your Advantage
David Fabian: The ides of March have brought additional volatility in the form of increasing price fluctuations in many of the major indices we track. Despite briefly hitting a new high in the SPDR S&P 500 ETF (NYSEARCA:SPY) this month, we have seen an increase in fear brought on by slowing growth data in China and political uncertainty in Ukraine.
This fear has put a bid under safe haven assets such as gold, treasuries, and even VIX futures. The iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX) gained more than 7% this week as traders reduced their exposure to equities and hedged their bets with options. A rising VIX typically means that we are seeing a shift out of risk assets and into a more defensive posture.
Right now investors are likely looking at their portfolios to determine if they should be reducing exposure to stocks in anticipation of a pullback or if this is just going to be another minor speed bump in the road. Both sides of the argument are valid considering both how resilient the market has been over the last 18 months and how long we have gone without a true correction.
One indicator I track is the CBOE Put/Call ratio which can be a contrary indicator of options activity. As of 3/13/14, the ratio stood at 104% which means that put options significantly outweighs call positions. Often times when this ratio reaches an extreme high or low, we will see a reversal as sentiment gets stretched. The last time this ratio popped over 100% was back on 10/9/13, right before stocks made a significant move higher.
The market still has some hurdles to climb in the form of global unrest, slowing economic data, and a host of other unforeseen events that could pop up on the horizon. Any one of these points could throw us for a loop and send stock prices lower. The only thing that is certain is that the uncertainty persists. However, there are numerous things you can be doing in the meantime to prepare your portfolio for additional volatility and capturing new opportunities.
- Make sure that you examine each of your existing holdings and how they held up vs. some of the broader benchmarks over the last several weeks. You may want to reduce exposure to underperforming positions or those with highly appreciated gains that you want to protect. Having some cash on hand to redeploy at more advantageous prices or shifting to benefit from a stronger trend can often times lead to better relative performance.
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