When fear defines financial markets, remember Warren Buffett. The great investor once said the secret to beating the market was to be fearful when others are greedy and greedy when others are fearful.
It is a simple idea, but it’s hard to do, especially now, when no one knows what the coronavirus might do. Right now, it exists as a widespread yet not especially lethal outbreak, though some—like Buffett’s friend Bill Gates—fear it is a once-in-a-century pathogen. President Donald Trump insists that political opponents are using the virus to destabilize his administration. And the Federal Reserve lowered interest rates by half a percentage point, driving the 10-year Treasury yield to a historically low level, in order to blunt its impact.
It isn’t worth debating any of this because the stock market tells us everything we need to know. The Dow Jones Industrial Average dropped by 12% for the week ended Feb. 28, and the S&P 500 index and the Nasdaq Composite each lost 11%. It was the market’s worst week since 2008, and the volatility this past week has also been extraordinary.
That raises a key point. In the dark days of the credit crisis, the financial world was seemingly ending. Yet by March 2009, the worst was over, and some people set themselves up to make fortunes because they bought stocks during those dark days.
The great indicator that led them to buy when everyone else was selling was often their own discomfort. When the tape made them feel that they wanted to vomit from the stress, they bought stocks and sold bearish put options to buy stocks even lower. Others concluded that widespread interest in hedging stocks during the crisis—a sign of panic because it shows an insensitivity to price—suggested the market would stop declining.
This isn’t meant to imply the coronavirus will soon stop menacing the market. No one knows what will happen tomorrow. But if you invest today in a blue-chip stock, values may fluctuate, but your future investment will almost certainly be worth more—provided the virus doesn’t destroy the world.
Since the credit crisis, we have encouraged investors to practice “time arbitrage”—by taking advantage of current conflagrations in anticipation of better tomorrows. If you can buy and hold for a few years, today’s problems likely won’t be so severe.
To follow Buffett’s fear dictum, consider the humble cash-secured put strategy, which entails selling puts on quality stocks while setting aside the purchase price of the underlying stock in your brokerage account. Find stocks you can own for a few years or longer, and sell one- to three-month puts with strike prices that are just below the stock’s price.
Favor stocks like AT&T (ticker: T), with a dividend yield of about 6%, or Verizon Communications (VZ), with a yield of 4.5%. If the virus worsens, people will still speak on their mobile phones, surf the internet, and watch TV. Netflix (NFLX), the king of streaming content, should do well, too.
The put strategy is simple. If the stock advances rather than declines, you keep the premium. If the stock is at the strike price at expiration, you buy the stock. The real risk is that the stock falls far below the put strike price, and investors must cover the put at a higher price or buy the stock at the strike price even if it is trading lower. The strategy works for any stock you are willing to own until brighter days return.
Our fear strategy is like disaster prepping. Rather than hoarding water, ammunition, and canned goods, you are stockpiling quality stocks that often pay attractive dividends when many investors are fearful. This isn’t for everyone, naturally, but those who dare tend to win.
Originally Posted on March 5, 2020 – Be Like Warren Buffett in Times Like These. Here’s How.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from Barron's and is being posted with permission from Barron's. The views expressed in this material are solely those of the author and/or Barron's and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.
Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.
Disclosure: Options Trading
Options involve risk and are not suitable for all investors. For more information read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD). To receive a copy of the ODD call 312-542-6901 or copy and paste this link into your browser: