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Options Theory: You Can’t Escape Market Timing

October 8, 2020

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The Presidential election looms large. Like a boulder rolling down a hill, it’s picking up speed and a collision seems imminent. But will it crush us, or will it pop upon impact and release a cloud of confetti as Benjamins rain from the sky?

Some say you should buy ahead of the event, others say you should sell. If you’re a disciple of price like me, you’ll ignore the opinions and follow the trend. And right now it says buy, buy, buy.

But what if I’m an investor? Maybe I just funded my IRA with $6k cash. Or, perhaps I stumbled upon a lump sum that needs invested. Do I buy now or wait until the smoke of the voting battle to clear? Is one safer than the other?

Unfortunately they both have risks.

Let’s say you can buy 100 shares of SPY with your investment. Buying all 100 shares now means you’re taking the full risk TODAY.

If instead you buy 50 shares now and 50 shares in December after the election, then all it means is you’re taking the full risk of 100 shares in DECEMBER.

Some traders mistakenly believe that the first approach is riskier than the second. It’s not true. Furthermore, they may believe that buying all at once is market timing, but scaling-in twice over three months is NOT market timing. Again, this is not true.

Averaging in over time just means TAKING RISK LATER. It is an implicit bet that the market will be lower in December than now. If you average in over a longer period, such as one year, then it again means you’re simply betting the market will be lower one year out than it is today.

You could be right, of course, but the probabilities aren’t in your favor. Historically, the stock market has gone higher roughly three out of every four years. That means the odds are three to one against you that you’ll be buying at lower prices a year from now.

So why do it?

The answers are many. You’re nervous and scared. You don’t want to look dumb. Minimizing regret is more important than maximizing gains. In other words, you’d rather miss out on potential upside by only investing part of your dough now in exchange for not wallowing in regret and big losses if the market plunges over the next year.

Fair enough.

I have a few ideas for easing into the market with a pile of cash.

First: Scale-in over time. As mentioned above, the longer it takes you to invest the entire nut, the worse your overall performance has been historically. Scaling in over 3 months, then, is preferable to easing in over 3 years.

But if that’s what it takes to get in the game, then by all means, take your time. It’s better than sitting in cash for the rest of your life.

Second: Invest it all now, but more conservatively. If you’re not down with buying 100 shares of SPY outright, then sell a put option. Or sell covered calls. Or buy protective puts. Or some combination thereof!

Third: For the passive investor, consider tilting your stock/bond allocation to a conservative enough level to take risk now. If not 80/20, then 70/30, or 60/40, or whatever.

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One Reply to “Options Theory: You Can’t Escape Market Timing”

  1. Avatar PaulLiu says:

    This blog exemplifies why trading requires mastering the Technical Analysis: which provides an edge on market timing.
    Thanks for laying out different ways easing in investment.

    Happy Belated Birthday to You Coach Tyler!

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