Investing: NASDAQ (QQQQ) Puts as insurance

NASDAQ 100 Trust Shares (QQQQ)

RISK (MODERN PORTFOLIO THEORY) STATISTICS

N/A 3 Years Statistic QQQQ Category 0.01 -1.19 Beta (against Standard Index) 1.37 1.06 Mean Annual Return 1.53 1.12 R-squared (against Standard Index) 69.68 86.21 Standard Deviation 15.09 N/A Sharpe Ratio 1.09 N/A

5 Years
Statistic	QQQQ	Category
Alpha (against Standard Index)	-3.09	N/A
Beta (against Standard Index)	1.91	N/A
Mean Annual Return	-0.16	N/A
R-squared (against Standard Index)	80.79	N/A
Standard Deviation	31.80	N/A
Sharpe Ratio	-0.13	N/A

I believe that we are nearing the end of this bull market that started a few years ago. There are many reasons I think that this is the case:

• Presidential cycles: Usually the first and second year of a new president are down market years
  
• Liquidity: Growth in the money supply has slowed to nearly zero.
  
• Yield Curve: The difference between short term debt and long term debt has narrowed to almost nothing, this has been the most accurate predictor of a recession according to Federal Reserve research, and this is tied to liquidity declines.
  
• US Dollar: The precipitous drop in the dollar that was fuelling earnings has slowed
  
• Time: Cyclical bull markets in secular bear markets are typically shorter. Based on all historic bull markets we are passed the 50% mark.
  
• Earnings: Growth is slowing
  
• LEI (Leading Economic Indicators): Have been trending down for months
  

This has me worried primarily due to liquidity. Not the type of liquidity I mentioned above but the likelihood that investors will have to liquidate holdings of stocks that I'm invested in to meet margin calls on tech stocks. What really worries me is that the fall of the NASDAQ that I think is coming (and based on historical data will likely be lower than the 2001 bear market lows) is going to suck down the price of sound, undervalued companies. I hope that very few investors are both in Technology and Uranium (for example) but a sinking market is going to lower all boats!

Again I am hoping that resource stocks will fall with the market, but less so and then rise again as money will flow into the only asset class not doing quite so badly. I've invested in QQQQ puts and if the NASDAQ goes down and resource stocks up I'll make money on both sides (long resource stocks, short NASDAQ). However, if NASDAQ stocks go down and drag down resource stocks with them, I have a chance of making enough money on the NASDAQ puts to offset the losses. Ideally I would like a stash of cash on the sidelines to buy more if this happens, but with fundamentally significantly undervalued companies, I am choosing to stay fully invested and ride the tide.

These are my estimations 1-2 years out:

• Case 1 (10%): NASDAQ Up, resource stocks down: I have no reason to believe this will happen but I lose on both sides of the trade
  
• Case 2 (15%): NASDAQ Up, resource stocks up: Well I loose my QQQQ puts but I'll do well on my resource stocks, this is a good outcome
  
• Case 3 (35%): NASDAQ down: resource stocks down: There is a reasonable chance that the QQQQ options will balance out the drop in my long portfolio or at least cushion the blow and avoid margin calls.
  
• Case 4 (40%): NASDAQ down: resource stocks up: Best possible scenario and not entirely unlikely. There are completely different factors driving natural resources to those driving tech valuations.

I expect to end up somewhere around cases 3-4 and as time passes I think case 4 becomes more likely than case 3 as the lowering of interest rates as a result of the NASDAQ fall will probably cause liquidity to flood somewhere and natural resources are a good bet given the other fundamentally positive forces.

Anyone with exposure to the US market should well consider putting a little (10% or so) money into QQQQ LEAPS over the next 6 months. If the NASDAQ doesn't fall you had insurance (no one ever complained about paying car insurance premiums and never having a claim!) but the risk today in the NASDAQ is to the downside.

Tags: qqqq option, put spread, investing insurance, var risk

Investing: NASDAQ (QQQQ) Puts as insurance