When cash is king, and when it's not
Much of the talk about hedging into the so-called fiscal cliff has involved the use of options or volatility funds to take the edge off any market plunge. But one of the beauties of being a retail trader is the ability to simply sit on the sidelines, which is one way to go into the New Year.
Although I am not an advocate of the "cash is king" thesis, there are times when doing nothing is the most prudent course. I prefer to buy puts or long-volatility products to play situations when I think that volatility expectations are too low, but sometimes that can't be justified.
I had a conversation the other day about the possibility of just moving everything to cash from now into the beginning of the year. Most institutional investors and traders don't have that option, which is actually one reason that it is appealing.
It is also appealing if you don't like the idea of paying for protection. If the market pulls back, you get a great opportunity to get back in; if it doesn't, then nothing is lost.
But there are two issues here. The first is that the markets could surge, leaving you behind if you're in cash. The second is the psychological factor: If the market is 5 or 10 percent lower, will you be able to jump back in and take advantage of a "great buying opportunity"? On the other side, if the market is 5 percent higher, will you be able to buy back in, knowing that you have missed out on part of the run? Or will you then stay on the sidelines, risking missing out on any bullish follow-through?
This is why hedging with options can make more sense, depending on how you answer those questions. That way you stay in the market and, if you have structured your positions properly, you could profit if the market moves either higher or lower. Of course, with a position like that you do need volatility and you need to make sure you are not overpaying.
Yet there is still a lot to be said for sitting on the sidelines at a juncture such as this, especially during the holidays. And if you are one of those people who may have issues getting back into the market after the fallout, options can then be used to scale back into positions.
Options are great and they can give you necessary insurance and exposure. But sitting in cash can provide for truly happy holidays and peace of mind, something I wish for all in the coming weeks.
(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Dec. 12.)
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