Yesterday's equity market sell-off has brought us close to 700 on the S&P. My partner and I both feel that, if the S&P closes below 700, a whole new psychology will affect it, sending it down in a near free-fall for a while.
After patiently riding out a negative return to our January puts for most of the past six weeks, they have moved up by 50 percentage points in the past week, resulting in the commencement of selling the better-performing ones for returns in excess of 100%.
It's not particularly gratifying to bet on extreme market declines in order to profit from financial positions. But, as one of my prior research partners, and a fairly wealthy private investor counseled me, sometimes, you have to acknowledge market forces and go short.
Our February put options are now up about 70% for the entire portfolio, with at least one position returning over 100%.
Looking at our volatility measure, we expect this downward trend to continue for at least the next few months. One of the mathematical facts which affect the S&P now is how large a percentage change a given point move represents. Seven points down is now 1% of the index, instead of half of that, only last summer.
I saved an early January piece from the Wall Street Journal in which several market strategists made convincing cases for a -20% S&P in 2009. At least one thing that was prominently mentioned in article is coming true. As the effects of various negative performances cascade, the magnitude of the consequences are outstripping expectations.
Given the losses in the S&P thus far in 2009, a 20% or 30% decline this year in the S&P could easily mean several more months of significant losses, followed by large gains later in the year.
But for now, the various signals which I follow do not seem to be predicting any lasting trend up in the equity or derivatives markets any time soon.
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