Options Theory: Cash is King and Other Bear Market-isms
December 7, 2018
Last update: August 2021
The new market overlords bear the names of Volatility and Whipsaw. And they’re nasty brutes. The kind that steal your lunch money kick you when you’re down, and spit “yo mamma” jokes with pleasure. The antics of these bullies have been on full display since October.
Massive moves and overnight gaps have become commonplace, while wicked intraday reversals (like Thursday) are burning both bulls and bears. I’ve heard it said that if bear markets don’t scare you out, they will wear you out and, well, the wisdom of the phrase is currently being made manifest. Unless you truly are Jack Be Nimble, I suspect you may be suffering either fear or fatigue. And we’re only two months into what could be a long, dark winter.
So if this is your first bear rodeo, buckle up and commit to learning how to weather it with financial and emotional capital intact. Six weeks ago I outlined some of my favorite ideas for doing just that in “How to Trade in a Bear Market.” Today I want to explore the appeal of holding high cash levels.
And, side note, if you want a comprehensive and sumptuous meal chock-full of tasty ideas for surviving and thriving in a bear market then treat yourself to the Bear Market Survival Guide. Your wallet will thank you.
Cash is King
When stock prices are booming and interest rates are nil, cash becomes trash. But when Volatility and Whipsaw wrest control of the market, not to mention when interest rates rise to modest levels, well, cash is king. Let’s talk about passive investors for a moment. If you’re fully invested in stocks all the way down then how are you going to buy the fire sales transpiring on every corner?
Those that lack the dough to sow won’t reap the rewards come harvest time.
Many stocks are 20% off their highs. Some have fallen 30%. And a select few miscreants have fallen 50%. If this is a bona fide cyclical bear market, the ranks of these losers will grow. Trust you me. And while it undoubtedly sucks for shareholders who did nothing to ease the pain on the way down (like selling covered calls or buying protective puts), it provides a wonderful opportunity to grab that rare bargain — the one that arrives only once or twice a decade.
One of the simplest ways to downgrade exposure in a passive account is to shift the asset allocation. Fewer stocks, more bonds and cash.
Cash has optionality. It gives you the option to buy something, anything, at a future (hopefully lower) price.
In a bear market, cash-lacking-investors become victims of the volatility. In contrast, those flush with greenbacks are the victors. Bring on the volatility, they say. Take Amazon back to $1,000, Apple back to $120, and Mastercard back to $140. Because I failed to take a bite the first go around and, well, I’m hungry.
When you have cash, you root for market pain because you know how to turn it into eventual pleasure.
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One of my biggest concerns with current market conditions — and why I think cash should be my largest position — is the effect of news on prices. The market jump on the FED Chair’s softer comments, nothing solid, just a hope of some relief, showed to me that traditional technical methods may not be effective for the time being.