Options Theory: Overcoming Bullish Bias
June 30, 2022
I received a wonderful question on how to overcome or at least deal with bullish bias. Obviously, with stocks suffering the worst first half of the year since 1970, anyone with optimism in their eye has been battered and bruised. But it’s not always so. Indeed, it’s usually pessimists that get punched. As I’ve seen so eloquently put before,
“Pessimists sound smart. Optimisms make money.”
I have opinions aplenty on this topic, but let’s define “bullish bias” to make sure we’re on the same page.
To me, it means something like the following:
- Always looking for reasons to buy stocks and not to sell.
- Always assuming stocks will recover.
- One who struggles with or otherwise avoids trading on the short side of the market.
- Potentially fighting the trend by purchasing stocks that are sinking.
I’ll confess I have bullish bias as well. But the key is to prevent it from causing you to do dumb things. More on that in a minute. First, let me explain why I believe markets will continue to rise over time.
Because that’s what they do!
This is hardly a controversial take. It’s born from history and grown by logic. The vast majority of people wake up every day wanting to make their lives better. They do this in large part by buying goods and services. Combine that with a growing population and technological advances, and voila! corporate profits trend higher over time. So too do the stock market. Up and to the left. It was ever thus. Permanent advance punctuated by temporary declines.
When I say I have a bullish bias, I mean that I view every bear market as fleeting, temporary – common as dirt for the long-term investor. There have been no less than six in my life so far (I was born in 1984) and there will likely be another dozen or so before I depart. They’re all buying opportunities. Every single one.
The lower the market goes, the more optimistic I become. History demands it. With every additional percentage point lopped off the S&P 500, the future returns rise. How can this not make one more bullish? It’s not suffering through another 20% decline that should worry you. It’s missing out on the next doubling or tripling in stock values.
Lest you’ve drunk too deeply from the poisonous media spring, or obsessed too much on this year’s thrashing, allow me to share the long-term chart of the S&P 500 to place in context what was just the worst first-half stock performance in nearly half a century.
To the multi-decade investor, the past six months is but a blip.
Bottom line: if you’re going to have a bias – make it bullish.
Don’t Do Dumb Things
Now, just because the market rises over the long haul doesn’t mean those with a bullish bias can’t suffer, sometimes tremendously, in the short run. Here’s how I keep my bias in check.
First, I realize the difference between betting the entire stock market will recover and betting an individual stock will. The former is a bet with a 100% chance of eventual success. The latter is, as I expounded on in May’s Trading Justice Newsletter Charles Dow & the Origin of Indexes, one with terrible odds.
To wit:
“In Scale: The Universal Laws of Life, Growth, and Death in Organisms, Cities, and Companies, Geoffrey West calculated that “of the 28,853 companies that traded on U.S. markets since 1950, 22,469 (78%) died by 2009.” What’s more, “half of all companies in any given cohort of U.S. publicly traded companies disappear within 10 years.”
When I’m sowing seeds in the depths of a bear to be harvested at a later date, the lion’s share of my capital is going into a broadly diversified ETF like SPY, IWM, QQQ, and the like as opposed to a single stock.
Second, I don’t blindly buy downtrends. That alone saved me a bundle this year. And when I do venture into a battered chart, I wait until it’s oversold and IV is high enough to justify selling puts or put spreads. As my Trading Lab (shout to Team Phoenix) members will attest – the success of trading bullish this year has been spotty, but we’ve hardly gotten our clock cleaned. Our bag of top-shelf trade management tricks (mostly scaling in and out) has allowed us to navigate a treacherous environment. Our mock portfolio has been bullish all year long.
Third, position sizing is everything. With very few exceptions we’ve kept the losing trades contained. If you want to survive as a bull in a bear market, you have to be small and nimble.
Fourth, you don’t have to necessarily go against your bullish disposition and trade aggressively bearish when the market trend is down. Heaven knows I haven’t (nor has my lab). But you certainly shouldn’t keep beating your head against the wall by deploying short-term bullish trades when the market is anything but. Patience, dear trader, patience.
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