Last week The Conference Board reported, “The recent sequester has created uncertainty regarding the economic outlook and as a result, consumers are less confident.” Keep in mind the 10% correction that began last April 3 began on news reports the economy was slowing. While expectations for the first quarter GDP estimates are higher than Q4 2012, remember the market attempts to discount future economic conditions.
In terms of probability, for the last three years the months of April have seen the start of market corrections of between 10-19%, making another more likely. There is a Wall Street adage saying, “Sell in May and go away,” but in recent years the selling has apparently occurred anticipating May declines, as one renowned expert explained,
“Successful investing is anticipating the anticipation of others.” John Maynard Keynes
With these thoughts in mind, it seems prudent to have a hedging strategy ready for implementing based on a closed below an upward sloping trendline or perhaps a moving average. We suggest using a close below the 1538.57 bottom of this most recent irregular triangle consolidation.
One strategy is to keep open positions small during April, while another is to prepare a conditional hedge using the VIX options.
VIX Hedge
Based on the May VIX Futures price of 15.56 the at-the-money VIX options are the May 15 calls and puts.
Since the implied volatility of the VIX options is low relative the historical volatility, as mentioned above a long call position could provide a hedge in the event the VIX rises with a market decline. However, there is still time decay to consider, so adding a short put position creates a synthetic long and offsets most to the time decay and vega risk.
Here are the details based upon last Thursday’s prices. Keep in mind this hedge idea is conditional on a close below 1538.57 so the strike prices could be higher or even lower than these shown.
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The last trading is May 21. It is unusual to see the gamma, theta and vega offset entirely, but since this is a conditional trade it will likely change by the time the position is implemented.
BlackBerry (BBRY)
Last week we suggested considering a BlackBerry long April call spread with a short March 28 put as an earnings idea. We booked the trade last Monday for a .28 credit, including the short March 28, 14 put for .70 with an implied volatility of 159.08. After reporting on Thursday morning, the stock opened higher and then closed -.13 for the day as the implied volatility declined from 92.49 to 66.76. The March 28 put at the 14 strike expired, so the entire premium went into the gain column. Marking the outstanding long April 16 call, short the April 18 call to market, added another .26 credit for a net .54 credit. In the event it closes at the short 18-strike price at the April expiration, the net gain would be 1.58 for the call spread plus .70 from the expired short put for a total gain of 2.28.
However, we suggest it is just as likely that it will now decline so a close below the March 25 low at 13.64 is the SU (stop/unwind) to watch in order to protect the credit.
The suggestion above uses the closing middle price between the Thursday bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
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Summary
Just as the media begins reporting the new highs made by the S&P 500 Index we suggest being prepared just in case equities turn lower following the same course this April as they have for the prior three Aprils while still maintaining some long positions in the event this April does not mark the beginning of a correction.