The stock market sold off last Thursday. Even gold could not avoid the collapse, as the October gold futures plummeted to $1,700. We have the debt crisis in Europe, with Greece facing a default situation unless its austerity program is accepted by lenders. Moody’s downgraded eight Greek banks after several Italian banks were also downgraded.
Watch the S&P 500 as it nears a critical support level of 1,125 and the four-week low at 1,114. A break could send the index down to below 1,100.
Small-caps are getting hammered, with the Russell 2000 down over 26% from its high and now technically in a bear market.
Watch over the next few days to see if oversold buying emerges.
There is nowhere to hide. Even gold and metal plays are being dumped despite gold being a safe-haven play. Investors are clearly dumping everything.
This could be an opportunity to buy on weakness; but, without a firm base, there could be additional downside moves.
Watching your asset value decline is not great, but you can minimize the effect.
I continue to recommend using put options or buying short-based exchange-traded funds (ETFs) to offset the weakness. It’s easy and cost-effective as a defensive hedge.
Don’t be put off by options. They are a great risk-management tool that is more than often overlooked by the retail investor or trader, but used often by the pro traders and institutions. The SPY index option that tracks the S&P 500 is a top trader on the CBOE.
You can buy puts for stocks and sectors.
Take a look at your holdings and break them down according to the sector, whether they’re technology, industrial, small-cap, large-cap, etc.
The second step is to take a look at the various indices that closely reflect your holdings.
If you are heavily weighted in technology, you can buy put options on the PowerShares ETFs (NASDAQ/QQQ), a heavily traded ETF in technology.
Or let’s say you have benefited from the run-up in gold and silver to record historical highs, a strategy may be to buy put options on the Philadelphia Gold & Silver Sector (NASDAQ/XAU), which tracks 16 major gold stocks and silver stocks.
To play the near-term downside weakness in small-caps, you could buy the ETF ProShares UltraShort Russell 2000 (NYSE/TWM).
Alternatively, if you hold a large position in several stocks, you can buy put options on these individual stocks and help protect against a major downside move.
Be careful and remember that maintaining your capital will allow you to trade longer-term.
With the upside limited at this point, you may also want to write some covered call options to generate premium income and reduce the average cost base of your positions. But be careful, as an oversold rebound could take out your position at the call strike price. Make sure you are comfortable with the upper strike price of your covered call. Make sure it’s above the key resistance of the stock.
The key now is prudence and protecting your assets.