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As you can see the NASDAQ average is up 2.64% more than the S&P 500 index, and 3.67% more than the Dow.
One of the reasons I think the market may be due for a short term correction is because the Volatility Index (VIX) spiked 5.15% today, while the markets finished higher. Based on historical data the VIX and S&P 500 have an inverse relationship - VIX trades lower on days where S&P 500 is up and higher on days where S&P is down (see chart below). The VIX spiking on an up day tells me many are factoring in a sell off ahead.
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As stated before in my blog; with all the cash on the sidelines (getting dirt cheap returns), this market could keep rallying with better than estimated earnings reports, and outlooks of an improving economy, however it never hurt anyone to take profits and protect on the downside a bit.
In this blog post I will outline 20 option ideas which will provide a return (if the market keeps rallying and the stock is assigned at expiration), as well as downside protection on the stock (in case the market happens to sell off). Therefore to understand this post, you'll need a general understanding of stock options. To learn more about options and, how options can help protect your portfolio, and allow you to speculate with less money up front; check out my book here.
As stated in the beginning of this post, I think stocks in the NASDAQ will suffer the greatest pull back if we get any type of correction. Therefore I chose to analyze the top 20 stocks in the NASDAQ 100. To download an Excel spreadsheet I created which ranks the NASDAQ 100 stocks by market cap with the click of a button click here.
All data as of market close Monday July 27, 2009.
The stocks are in order from greatest to least market cap. The first stock in the table below is Microsoft (MSFT) to understand how to read the table I'll give a worded example using Microsoft. The example assumes the stock was being purchased and immediately written out for the August options expiration.
Purchase Microsoft (MSFT) stock, and sell the August 23 strike call option. The premium received from the call option would give a downside protection of 3.20%. If the stock is assigned at options expiration on August 22, 2009 the total return from this position would be 2.73%. The current options market is factoring in a 31.3% probability Microsoft will be at or above 23 a share by August options expiration.
|Company||Symbol||Strike||Protection %||Return %||Probability %|
|Cisco Systems, Inc.||CSCO||22||3.30||4.03||48.6|
|Teva Pharmaceutical Industries Ltd (ADR)||TEVA||52.5||1.27||4.01||33.8|
|Gilead Sciences, Inc.||GILD||50||1.63||3.78||38.4|
|Research In Motion Limited (USA)||RIMM||80||2.84||5.94||40.8|
|The DIRECTV Group, Inc.||DTV||26||3.45||3.22||53.2|
|Infosys Technologies Limited (ADR)||INFY||42.5||3.77||3.89||51.4|
All of these options expire on August 22; therefore the last trading day is Friday, August 21, 2009.
These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.
This strategy will give protection if the market sells off, as well as provide a return if the market continues to rally. If the stock is not assigned, this strategy is a great way to create additional income for your portfolio. The reason option volumes have exploded over the past 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares. To learn more about stock options check out my book. Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.
For your convenience, below is a printable spreadsheet, which ranks the stocks in this analysis in order from least to greatest protection % and if they are above the average (of the 20 stocks analyzed) by highlighting the % (click image to enlarge).
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