Protection against a sharp drop

[DaveC]

I'm sticking to the strategy, but getting very nervous about a sharp drop in the VTI. I wonder if anyone has considered buying a put on this at say 10% below the current price. It looks like it would cost less than 1% of the current price for a put good for about 130 days. Seems like cheap insurance to me. I would not exercise the put if there were a big decline, because that would be the time to buy more VTI. But I could sell the put to cover the decline below 10%. What do you all think?

[MediumTex]

We saw huge stock market losses in 2008 and 2009 and the PP held up fine.

More recently, we saw huge declines in the price of gold and the PP held up fine.

I wouldn't worry about it.

[AdamA]

Seems like cheap insurance to me.

One of the nice things about the PP is that it has insurance built in, so you don't really have to worry about this type of thing.

A VTI put might be a fun VP gamble, but I wouldn't mix it in to your PP.

Also realize that most people lose with options.  Especially retail investors.
Still, it can fun to fool around with them as long as you realize that it's more a form of entertainment than an investment strategy.

[Pointedstick]

Trying to hedge a potential loss with puts seems a little like buying gambler's insurance from a casino.

[stuper1]

You gotta love the analogies that pop up on this forum.

[DaveC]

Well  there comes a time when you just worry that the ice is getting thin on one of the assets based on historical precedents. I think that might be the case now with stocks. Of course the PP works anyway because it forces you to buy low and sell high. The way I see this is suppose I have a 25-25-25-25 portfolio where the first 25 is stocks and the last 25 is cash. Stocks tank and gold and long bonds go up so I get 15-30-30-25 which makes me re-balance to 25-25-25-25. I have not lost or gained anything except I have sold some gold and bonds after they went up 20% and I bought more stock after it went down 40%. So this has to put me in a better position for the future and is surely the opposite of what most individual investors do due to their emotional tendencies to buy after things go up and sell after things go down.

But suppose I buy a put on stocks at 90% of their current (apparently inflated) value and the same thing happens. Nothing changes in the PP. I go from 25-25-25-25 to 15-30-30-25 re-balancing back to 25-25-25-25. But I picked 90%(25)-15 = 7.5 via the put which only cost me 1%(25) = 0.25! If I guessed wrong and stocks did not tank, I only lost the 0.25. Again this seems like a small price to pay for peace of mind given my current concern about the stock market.

[stuper1]

If the cost of the put is money you can afford to lose, then you could look at buying the put as part of your VP, and then you won't have to worry about HB rolling over in his grave.

As for me, I'll just stick with the plain PP.

[MediumTex]

Well  there comes a time when you just worry that the ice is getting thin on one of the assets based on historical precedents. I think that might be the case now with stocks. Of course the PP works anyway because it forces you to buy low and sell high. The way I see this is suppose I have a 25-25-25-25 portfolio where the first 25 is stocks and the last 25 is cash. Stocks tank and gold and long bonds go up so I get 15-30-30-25 which makes me re-balance to 25-25-25-25. I have not lost or gained anything except I have sold some gold and bonds after they went up 20% and I bought more stock after it went down 40%. So this has to put me in a better position for the future and is surely the opposite of what most individual investors do due to their emotional tendencies to buy after things go up and sell after things go down.

But suppose I buy a put on stocks at 90% of their current (apparently inflated) value and the same thing happens. Nothing changes in the PP. I go from 25-25-25-25 to 15-30-30-25 re-balancing back to 25-25-25-25. But I picked 90%(25)-15 = 7.5 via the put which only cost me 1%(25) = 0.25! If I guessed wrong and stocks did not tank, I only lost the 0.25. Again this seems like a small price to pay for peace of mind given my current concern about the stock market.

By the early 1980s, stock investors had been beaten down and demoralized for so long that they looked at any stock rally with skepticism.  If these investors had felt the need to hedge against stock market drops for the entire 1982-2000 period, they would have been in an endless process of trying to plan for when the ridiculous bull market for stocks was going to end.

In the context of the PP, however, you are automatically hedged against stock market declines, so I wouldn't worry about it.

Actually, if the PP has a weakness, it's that its boring returns during bull markets for stocks can make it very tempting to abandon the strategy.  In other words, PP investors should probably fear stock market advances more than they should fear stock market declines.

[barrett]

Actually, if the PP has a weakness, it's that its boring returns during bull markets for stocks can make it very tempting to abandon the strategy.  In other words, PP investors should probably fear stock market advances more than they should fear stock market declines.

But that is mostly because individuals don't generally invest in gold or LTT's, right? They are invested in stocks and you hear about it from them when "the market" is doing well. If they hold bonds, it's most likely in a fund that has less volatility than 30-year treasuries. The bonds are just there to smooth the bumps a bit. The financial news, at least on the radio or television, seems to be almost entirely about stocks and it's natural to feel you are missing out if you "only" have 25% in equities. We certainly don't fear advances in gold. Good point though, MT. Does anyone here have a feel for whether or not this fixation on stocks was also the case during the 1970's? Or were people obsessing about not having enough cash?

[portart]

The PP takes some getting used to. I have been in it over ten years and it has been very good to me. My gains have slightly out earned an all stock S/P portfolio over the same period of time without all the teeth nashing. Last year was a test . The portfolio was down slightly against a roaring stock market. I kept in there rebalancing and this YTD is already ahead of all last year by getting all the gold at lower prices on a rebalance. Seeing the historical average of the PP gives you faith to stay with it no matter what the experts predict. Also TLT is up nicely this year against all the predictions. I already sold some of those profits (retirement acct so no tax penalty) and used it for rebalancing... Nice

[sophie]

Does anyone here have a feel for whether or not this fixation on stocks was also the case during the 1970's? Or were people obsessing about not having enough cash?

I guess you'd have to say "no".  Unless you were uber-wealthy, you didn't mess around with the stock market.  There was no such thing as index funds, and the fees to buy stock share certificates were high.  If you were an ordinary person and had some money to save, it went into a Christmas club or passbook savings account yielding something like 5% plus the free toaster.  You didn't worry about retirement savings because there was no such thing as 401k's, you worked at the same place for your entire career, and you had a nice pension waiting for you upon retirement.  If you did venture into the stock market, you picked a company, bought some shares to hold and collect dividends, and kept an eye on the price by checking the stock tickers in the newspaper every once in a while.  It's unlikely that more than a handful of small stockholders kept records sufficient to track annual returns.

Nicely nostalgic, isn't it?  Sort of like that other thread about area codes.

[gizmo_rat]

I have been in it over ten years and it has been very good to me... I kept in there rebalancing.

Just out of curiosity what rebalancing method have you used over the 10 years ?

In 3 years I've seen some sharp drops but have yet to hit a 15/35 band, I kind of feel I'm missing out on any rebalance advantage. 

[rutabaga]

If your Put expires worthless, will you buy another one? And after that?

[DaveC]

rutabaga - Well good question.

I went ahead and bought the put at 90% of the current VTI. 

If the VTI goes up another 10%+, yes I would definitely buy another one. I would be happy to do so as I would be 9%+ ahead.  If it goes down 30-40%, I would re-balance (buying more VTI) using the other PP funds plus the cash from selling the put. I would not buy another put in that case as the market would have already corrected.

But your question is probably directed toward what happens if the VTI doesn't change much. Assuming nothing has happened to change my opinion that the market is seriously over valued, I would buy another one.

I realize that this is kind of contrary to the PP philosophy of not trying to judge whether the market is over or under valued. But when the market appears to be WAY over valued (see the Hussmann thread in this group), it seems prudent to buy a little insurance.

[HB Reader]

Does anyone here have a feel for whether or not this fixation on stocks was also the case during the 1970's? Or were people obsessing about not having enough cash?

I guess you'd have to say "no".  Unless you were uber-wealthy, you didn't mess around with the stock market.  There was no such thing as index funds, and the fees to buy stock share certificates were high.  If you were an ordinary person and had some money to save, it went into a Christmas club or passbook savings account yielding something like 5% plus the free toaster.  You didn't worry about retirement savings because there was no such thing as 401k's, you worked at the same place for your entire career, and you had a nice pension waiting for you upon retirement.  If you did venture into the stock market, you picked a company, bought some shares to hold and collect dividends, and kept an eye on the price by checking the stock tickers in the newspaper every once in a while.  It's unlikely that more than a handful of small stockholders kept records sufficient to track annual returns.

Nicely nostalgic, isn't it?  Sort of like that other thread about area codes.

Yeah, that is pretty much my recollection.  It wasn't until the very late 1970s that money market funds began to appear.  I think many small investors were also more likely to be looking to buy rental real estate than stocks.  Stock commissions weren't deregulated until 1975 and were usually very (outrageously) high.

[Pointedstick]

I realize that this is kind of contrary to the PP philosophy of not trying to judge whether the market is over or under valued. But when the market appears to be WAY over valued (see the Hussmann thread in this group), it seems prudent to buy a little insurance.

Assuming you run a mostly-normal PP, isn't your "insurance" against market drops the fact that bonds and/or gold would respond positively?

What will you do if the market keeps going up and up and up? Keep buying worthless puts? It seems to me like like you're letting yourself try to predict the future. How do you know the market is truly overvalued? To me it looks like the real economy is finally beginning to pick back up again, and if anything, it's beginning to bridge the gap we've seen between its performance and that of the equities market. In such a situation, stocks may well skyrocket.

Then again, I  have no idea whether I'm right nor not, so I'm sticking to my put-less 4x25PP.

[Kshartle]

To me it looks like the real economy is finally beginning to pick back up again, and if anything, it's beginning to bridge the gap we've seen between its performance and that of the equities market. In such a situation, stocks may well skyrocket.

PS what are you seeing that makes you think the economy is picking up? I imagine we are looking at the same stuff and interpreting it differently.

That being said I think stocks will continue heading up generally, although I think they'll have a tough time making a new high until Yellen annouces a taper to the taper.

The puts might make some cash. Today was quite a little sell off into the close. I think we need to test the lows from a couple weeks ago but I'm not nimble enough to want to try and trade it.

[Pointedstick]

To me it looks like the real economy is finally beginning to pick back up again, and if anything, it's beginning to bridge the gap we've seen between its performance and that of the equities market. In such a situation, stocks may well skyrocket.

PS what are you seeing that makes you think the economy is picking up? I imagine we are looking at the same stuff and interpreting it differently.

That being said I think stocks will continue heading up generally, although I think they'll have a tough time making a new high until Yellen annouces a taper to the taper.

The puts might make some cash. Today was quite a little sell off into the close. I think we need to test the lows from a couple weeks ago but I'm not nimble enough to want to try and trade it.

I see hiring. Friends who have been unemployed have found work. Friends who are employed are able to switch jobs easily. Restaurants seem more filled than they've been. Inflation seems to be picking up too. That pricing power can't come about without a corresponding increase in purchasing power. I think, if I had to hazard a guess, that this is where we could disagree. But my personal experience is what informs my opinion. As a small businessman, even if I wanted to raise my prices, I couldn't do it if my customers didn't have  the money to afford it. I'd just be left with lower sales and actually hurt myself. On the other hand, when my customers are doing well and I feel like I'm in a good position vis-a-vis my competition, my pricing power is very high.

[Bean]

Inflation seems to be picking up too. That pricing power can't come about without a corresponding increase in purchasing power. I think, if I had to hazard a guess, that this is where we could disagree. But my personal experience is what informs my opinion. As a small businessman, even if I wanted to raise my prices, I couldn't do it if my customers didn't have  the money to afford it. I'd just be left with lower sales and actually hurt myself. On the other hand, when my customers are doing well and I feel like I'm in a good position vis-a-vis my competition, my pricing power is very high.

Inflation can also be raised due to COGS and a price increase to maintain IMU.  Increased income has minimal influence on current inflation, it is simply more competition or less availability of a limited goods.

I am positive this is the current cause of inflation because of what I do for a living.