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Why Long-Term Investor Over Short-Term

Long-term investing is delayed gratification, whilst short-term is income-orientated. The stock market has averaged 9% per year over the long term. Vanguard has a suitable ETF for long-term passive investors. Bearish signs on the S&P 500 and Gold in the short term, but Gold in the long term looks attractive from here. This is an important question to ask yourself before you invest capital into the markets. “Start with the end in mind” is a good question to ponder over your investment goals. Do you want to be active or passive? Do you want regular income or are you going to leave your money to compound over time? What about day trading? The answer to these questions is going to be different for everyone but they are definitely questions you should ask yourself before you start investing. Let’s discuss some long- and short-term set-ups at present so you can have a better idea on the strategy that suits your personality the best. So what’s your end goal here if you want a career in investing? Well there are 2 extremes. You can learn to become a compounding long-term giant like Warren Buffett or a day trader or even a high-frequency trader where your sole objective is daily income. Long-term investors do their due diligence on multiple companies, and usually hold onto their underlyings for at least 6 to 12 months, if not years, before thinking of liquidating. Day traders and short-term investors, on the other hand, mainly look at charts, moving averages, volatility and sentiment in order to predict short-term direction. Long-term investing brings many advantages. You are not glued to your screen everyday watching for every uptick. Professional investors’ “modus operandi” is to thoroughly research companies and then make their decisions accordingly. This is where the big gains are because you are effectively an insider. You know information about startups that the public doesn’t. If you want to be in this game full time (this being your career), I believe that is the end goal. Nevertheless, not everyone has that sort of time when starting out, so let’s take a look at the steps you could take to get to your end goal faster. Most investors are definitely passive, as there are constraints on their time. This is definitely the best way to start out. There are many vehicles such as (NYSEARCA: VTI ) that average between 8% and 9% before tax annually over the long term. It is very difficult to beat the market when starting out, so this is a good strategy for an investor starting out on their career. Compounding works over time in your favor, and if you start out with a sizeable balance and also add to it regularly, it can turn into a sizeable amount of capital after some time. Every “saver” should adopt this approach as it is extremely difficult to get rich on savings alone. In our 1% portfolio, we have many equities that we will not sell at a loss because we are adopting the above principle. Our chosen equities will at least match the returns mentioned above. Many investors talk about the 2008 crash and how equities lost 50% of their values. However, many quality blue chips recovered and now have much higher prices than 2007. Let’s take a look at 2 of our holdings in our portfolio, Kellogg (NYSE: K ) and Coca-Cola (NYSE: KO ). We are not putting stop losses on these underlyings. Take a look at charts below to see their action over the last 10 years. (click to enlarge) (click to enlarge) As you can see, both companies recovered after the 2008 crash and for good reason. Both companies are leaders in their industries and cash rich. Even when stocks were plummeting in 2008, these companies raised their dividends. Kellogg has now raised its dividend for 10 straight years, and Coca-Cola has done the same for 52 years straight! Both are now yielding just under 3% for shareholders, but the yield was far higher in 2008 as dividends and stock prices converged. These stocks should definitely at least match the stock market going forward. This is why we will never sell them at a loss, as we know they will recover over time . These types of stocks give you a buffer (support) through good fundamentals and increased dividends. Let’s look at Gold also over a 10-year period. Gold has definitely been in a bull run since 2000. Have a look at the chart below of (NYSEARCA: GLD ) (ETF that tracks the price of Gold) to confirm. (click to enlarge) The startling fact is that amidst all the doom and gloom surrounding Gold recently, the precious metal is still up almost 180% over the last 10 years, which beats the stock market by double. With all the easing measures that central banks are adopting at present, Gold should rise from here if the bankers can’t halt deflation in its tracks, so I see no reason for selling Gold now, assuming you are a long-term investor. Nevertheless, let’s now look at short-term outlooks for both the stock market and Gold. Obviously, if the stock market corrects, our selected underlyings will also correct and definitely the stock market is more overbought now than Gold (period of 3 to 5 years). Look at the chart of (NYSEARCA: SPY ) below. As you can see, the S&P has run through its 50-day moving average, but more importantly, the trend line from the October lows last year to the December and January lows have been broken. This should imply downward action in the stock market for the next month or so but the slide may be halted by the upcoming FOMC meeting, which takes place on the 29th of this month. These meetings have acted as support for the market in the past, so I wouldn’t be surprised if the meeting puts a temporary floor under the market yet again later this month. (click to enlarge) Gold in the short term doesn’t look that attractive either. The volume in (NYSEARCA: DUST ) has spiked (see chart). This is an inverse leveraged ETF (x3 in the mining sector), and usually gives good predictions about where the mining sector is going in the short term. (click to enlarge) Also, when you look at the chart of (NYSEARCA: GDX ), you see that the mining ETF has printed a bearish candle in the last few days and the RSI levels are rather high. (click to enlarge) So how do you want to invest?. Do you want to hold through the down moves or sell? (passive or active). You need to answer this question before you start investing. Neither one is right nor wrong but one thing is clear. If Gold goes to the stratosphere, the long-term Gold bulls who own low-cost ETFs or physical will do very well. They have less trading costs, less headaches about short-term movement in price and obviously more compounding of their capital. If you decide you want to be a short-term or swing trader, be willing to invest the time because you will really have to sharpen your technical skills before being able to beat passive investors, but it most certainly is possible. Also nobody talks about the time involved when trading short-term. Passive investors are using that time to make money in other areas or researching other companies. What’s that time worth to passive investors, another 2%, 3%, 5% annually? These are only questions you can answer… Personally, I like to combine both but I always try to veer towards being long-term and fundamentals. Invariably, this means that the income from my short-term investments varies a lot every month, as I give precedence to my long-term goals.

DGRW Is A Solid ETF In Every Metric, But Still Faces An Uphill Battle

Summary I’m taking a look at DGRW as a candidate for inclusion in my ETF portfolio. The risk level on the ETF looks good with heavy trading volume. The yield is lower than I would expect for an ETF focused on dividend growth. The exposure to oil companies might be a bit much when I’m also planning a portion of my portfolio for natural resources. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. How to read this article : If you’re new to my ETF articles, just keep reading. If you have read this intro to my ETF articles before, skip down to the line of asterisks. This section introduces my methodology. By describing my method initially, investors can rapidly process each ETF analysis to gather the most relevant information in a matter of minutes. My goal is to provide investors with immediate access to the data that I feel is most useful in making an investment decision. Some of the information I provide is readily available elsewhere, and some requires running significant analysis that, to my knowledge, is not available for free anywhere else on the internet. My conclusions are also not available anywhere else. What I believe investors should know My analysis relies heavily on Modern Portfolio Theory. Therefore, I will be focused on the statistical implications of including a fund in a portfolio. Since the potential combinations within a portfolio are practically infinite, I begin by eliminating ETFs that appear to be weak relative to the other options. It would be ideal to be able to run simulations across literally billions of combinations, but it is completely impractical. To find ETFs that are worth further consideration I start with statistical analysis. Rather than put readers to sleep, I’ll present the data in charts that only take seconds to process. I include an ANOVA table for readers that want the deeper statistical analysis, but readers that are not able to read the ANOVA table will still be able to understand my entire analysis. I believe there are two methods for investing. Either you should know more than the other people performing analysis so you can make better decisions, or use extensive diversification and math to outperform most investors. Under CAPM (Capital Asset Pricing Model), it is assumed every investor would hold the same optimal portfolio and combine it with the risk free asset to reach their preferred spot on the risk and return curve. Do you know anyone that is holding the exact same portfolio you are? I don’t know of anyone else with exactly my exposure, though I do believe there are some investors that are holding nothing but SPY . In general, I believe most investors hold a portfolio that has dramatically more risk than required to reach their expected (under economics, disregarding their personal expectations) level of returns. In my opinion, every rational investor should be seeking the optimal combination of risk and reward. For any given level of expected reward, there is no economically justifiable reason to take on more risk than is required. However, risk and return can be difficult to explain. Defining “Risk” I believe the best ways to define risk come from statistics. I want to know the standard deviation of the returns on a portfolio. Those returns could be measured daily, weekly, monthly, or annually. Due to limited sample sizes because some of the ETFs are relatively new, I usually begin by using the daily standard deviation. If the ETF performs well enough to stay on my list, the next levels of analysis will become more complex. Ultimately, we probably shouldn’t be concerned about volatility in our portfolio value if the value always bounced back the following day. However, I believe that the vast majority of the time the movement today tells us nothing about the movement tomorrow. While returns don’t dictate future returns, volatility over the previous couple years is a good indicator of volatility in the future unless there is a fundamental change in the market. Defining “Returns” I see return as the increase over time in the value known as “dividend adjusted close”. This value is provided by Yahoo. I won’t focus much on historical returns because I think they are largely useless. I care about the volatility of the returns, but not the actual returns. Predicting returns for a future period by looking at the previous period is akin to placing a poker bet based on the cards you held in the previous round. Defining “Risk Adjusted Returns” Based on my definitions of risk and return, my goal is to maximize returns relative to the amount of risk I experienced. It is easiest to explain with an example: Assume the risk free rate is 2%. Assume SPY is the default portfolio. Then the risk level on SPY is equal to one “unit” of risk. If SPY returns 6%, then the return was 4% for one unit of risk. If a portfolio has 50% of the risk level on SPY and returns 4%, then the portfolios generated 2% in returns for half of one unit of risk. Those two portfolios would be equal in providing risk adjusted returns. Most investors are fueled by greed and focused very heavily on generating returns without sufficient respect for the level of risk. I don’t want to compete directly in that game, so I focus on reducing the risk. If I can eliminate a substantial portion of the risk, then my returns on a risk adjusted basis should be substantially better. Belief about yields I believe a portfolio with a stronger yield is superior to one with a weaker yield if the expected total return and risk is the same. I like strong yields on portfolios because it protects investors from human error. One of the greatest risks to an otherwise intelligent investor is being caught up in the mood of the market and selling low or buying high. When an investor has to manually manage their portfolio, they are putting themselves in the dangerous situation of responding to sensationalistic stories. I believe this is especially true for retiring investors that need money to live on. By having a strong yield on the portfolio it is possible for investors to live off the income as needed without selling any security. This makes it much easier to stick to an intelligently designed plan rather than allowing emotions to dictate poor choices. In the recent crash, investors that sold at the bottom suffered dramatic losses and missed out on substantial gains. Investors that were simply taking the yield on their portfolio were just fine. Investors with automatic rebalancing and an intelligent asset allocation plan were in place to make some attractive gains. Personal situation I have a few retirement accounts already, but I decided to open a new solo 401K so I could put more of my earnings into tax advantaged accounts. After some research, I selected Charles Schwab as my brokerage on the recommendation of another analyst. Under the Schwab plan “ETF OneSource” I am able to trade qualifying ETFs with no commissions. I want to rebalance my portfolio frequently, so I have a strong preference for ETFs that qualify for this plan. Schwab is not providing me with any compensation in any manner for my articles. I have absolutely no other relationship with the brokerage firm. Because this is a new retirement account, I will probably begin with a balance between $9,000 and $11,000. I intend to invest very heavily in ETFs. My other accounts are with different brokerages and invested in different funds. Views on expense ratios Some analysts are heavily opposed to focusing on expense ratios. I don’t think investors should make decisions simply on the expense ratio, but the economic research I have covered supports the premise that overall higher expense ratios within a given category do not result in higher returns and may correlate to lower returns. The required level of statistical proof is fairly significant to determine if the higher ratios are actually causing lower returns. I believe the underlying assets, and thus Net Asset Value, should drive the price of the ETF. However, attempting to predict the price movements of every stock within an ETF would be a very difficult and time consuming job. By the time we want to compare several ETFs, one full time analyst would be unable to adequately cover every company. On the other hand, the expense ratio is the only thing I believe investors can truly be certain of prior to buying the ETF. Taxes I am not a CPA or CFP. I will not be assessing tax impacts. Investors needing help with tax considerations should consult a qualified professional that can assist them with their individual situation. The rest of this article By disclosing my views and process at the top of the article, I will be able to rapidly present data, analysis, and my opinion without having to explain the rationale behind how I reached each decision. The rest of the report begins below: ******** (NASDAQ: DGRW ) WisdomTree U.S. Dividend Growth Fund Tracking Index: WisdomTree U.S. Dividend Growth Index Allocation of Assets: 80% Invested in components of the index or other securities that are considered to be almost identical Morningstar Category: Large Blend Time period starts: June 2013 Time period ends: December 2014 Portfolio Std. Deviation Chart: (click to enlarge) (click to enlarge) Returns over the sample period: (click to enlarge) Correlation: 96.34 Liquidity: 498,146 average shares/day Days with no change in dividend adjusted close: 10 Yield: 1.77% Expense Ratio: .28% Discount or Premium to NAV: .23% premium Holdings: (click to enlarge) Further Consideration: Yes. I am planning to allocate a portion of my portfolio to focus on dividend growth stocks because I want them to be over-weighted in my portfolio. Conclusion: DGRW doesn’t offer much in the way of diversification with a correlation that is over 96% and 10 days with no change in dividend adjusted close. There were only 2 days where SPY reported no change in dividend adjusted close during the same period. DGRW having 10 days rather than 2 may simply be a rounding error because DGRW trades around $31 to $32 and SPY is trading at over $200. A one cent movement in DGRW is similar to a six cent movement in SPY. The liquidity based on shares/day combined with the relatively low standard deviation results in an ETF that should fit nicely into portfolios that are requiring some liquidity. However, the distribution yield of 1.77% (lower than SPY’s 1.87%) is interesting for an ETF that suggests dividends are a primary focus. The expense ratio isn’t too bad and wouldn’t be enough to scare off, though I would prefer to buy closer to NAV since I expect to rebalance frequently which makes spreads and premiums or discounts more important to my strategy. With this much liquidity I would expect spreads to remain fairly small whenever the market is open and I would expect the premiums to disappear fairly fast. My biggest concern on this ETF would probably be the concentration of holdings. I don’t mind having a large position in Exxon Mobil, but I may be creating that position through an ETF that focuses on exposure to natural resources. Since I intend to include sections for a replacement for SPY and an allocation to an ETF that focuses on dividends, there will naturally be some significant exposure coming from three ETFs, but I’d like to keep the company specific risk as low as possible so that no company can compose more than 2 to 3% of my portfolio. Since the yield on the ETF is relatively low and it substantially overlaps with other positions I intend to create, I think it will face a slightly uphill battle despite being attractive ETF. As shown from the ending Portfolio Value, the high correlation also has a very similar total return. That isn’t always the case when using daily standard deviation, but it has been the case for DGRW. Comments I’m testing a new layout for my ETF articles. It is intended to optimize the articles for my followers. Let me know what you think of the new layout in the comments section. I’m always looking for feedback and trying to find ways to improve my writing for my readers.

The Time To Hedge Is Now! January 2015 Update

Summary Brief overview and links to earlier articles in the series. Why Buy-and-hold investors should consider hedging. Sell your January 2014 puts in Terex (TEX) before expiration this Friday and lock in profits. Improved buy prices on select candidates. Discussion of the risks inherent to this strategy versus not being hedged. Back to December Update – Part II Strategy Overview If you are new to this series you will likely find it useful to refer back to the original articles, all of which listed with links in this instablog . In the Part I of this series I provided an overview of a strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works and gave the first two candidate companies to choose from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how it can help grow both capital and income over the long term. Part III provided a basic tutorial on options. Part IV explained my process for selecting options and Part V explained why I do not use ETFs for hedging. Parts VI through IX primarily provide additional candidates for use in the strategy. Part X explains my rules that guide my exit strategy. All of the above articles include varying views that I consider to be worthy of contemplation regarding possible triggers that could lead to another sizeable market correction. Part II of the December Update (linked at the top of this article) explains how I intend to roll my positions. I want to make it very clear that I am not predicting a market crash. Bear markets are a part of investing in equities, plain and simple. I like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then I like to hold onto to those investments unless the fundamental reasons for which I bought them in the first place changes. Investing long term works! I just want to reduce the occasional pain inflicted by bear markets. Why Hedge? With the current bull market turning 70 months now, it is now more than double the average duration (30.7 months) of all bull markets since 1929. The current bull is now longer in duration than all but three bull markets during that time period (out of a total of 15). So, I am preparing for the inevitable next bear market. I do not know when the strategy will pay off, and I will be the first to admit that I am probably earlier than I suggested at the beginning of this series. However, I do feel confident that the probability of experiencing another major bear market will rise in the coming year(s). It may be 2015, 2016 or even 2017, before we take another hit like we did in 2000-2002 or 2008-09. But I am not willing to risk losing 50 percent (or more) of my portfolio to save the less than two percent per year cost of a rolling insurance hedge. I am convinced that the longer the duration of the bull market lasts the worse the resulting bear market will be. Sell TEX January 2015 puts now! I don’t like to hold short positions, especially on dividend paying stocks. Even though the dividend is tiny on TEX, I recommend selling the puts now. I sold two of my TEX put positions yesterday ($26 and $27 strikes) and am happy with my returns (680% and 809%, respectively). I also sold the last batch today ($23 strike) for a small profit. The bull market churned ever higher while we remained hedged and one of our candidates fell enough to help offset part of the cost of the hedge. I hope you held TEX puts in your hedge! Overall the hedge position (all 18 positions) lost money. All in all, because of the one good outcome my portfolio was hedged for most of last year for less than one percent. I estimate that this next year may cost over 1.5 percent of our total portfolio (I pay for mine by giving up a portion of my dividend income) if we buy all the puts today. However, there are some events coming up soon that could spur U.S. equities higher in the short term, depending on the outcomes. Pending Economic Events The biggest two events that are on the schedule, in my view are the European Central Bank [ECB] decision to increase quantitative easing coming on January 22 and the Greek election set for January 25, just three days later. I want to thank Mercy Jimenez for reminding me of these two important dates coming in the third week of this month. The ECB decision could provide a boost, if QE is initiated and is large enough to matter, to U.S. equities via the carry trade. Those with access to very low cost money in the Euro Zone will borrow cheaply there and reinvest where they expect high and safer returns; that would be the U.S as investors continue their flight to perceived safety). Both U.S. bonds and equities stand to benefit if the vote is positive. Currently, the plan does not seem settled as to the total amount of QE that the ECB will provide. Most recently I have read articles stating that 500 billion euros (just under $600 billion U.S.) is likely. However, a few days ago I read that the ECB was planning a one trillion euro (almost $1.2 trillion U.S.). I suspect the lower amount is more likely. On the other hand, if the measure does not pass, there could be a negative reaction as those who had positioned investments to take advantage of an expected run up would probably unwind those positions. The Greek election outcome appears to favor the Syriza party which is anti-bailout and wants to renegotiate the austerity terms required for more loans. If the Syriza party prevails and negotiations stall, it could bring the sovereign debt question in Europe back to the forefront. That could either hurt or help U.S. equities, depending upon how the outcome and its consequences are interpreted. If both votes go sour, then we want to be hedged because all bad news from Europe could cause enough fear in the global investors to go to cash. U.S. bonds would probably find support, but a risk off environment would likely result in a correction to equities. Being partially hedged at this point is a good bet. If the vote on QE by the ECB passes, we could get a good opportunity to buy more puts at lower premiums in the near future. Patience is the key. Current Premiums on select Candidates In this section I will provide current quotes and other data points on selected candidates that pose an improved entry point from the last update. All quotes and information are based upon the close on Wednesday, January 14, 2015. I am calculating the possible gain percentage, total estimated dollar amount of hedge protection (Tot Est. $ Hedge) and the percent cost of portfolio using the “Last Premium” amount shown. This was the last premium paid on the last transaction of the day and provides a more accurate example of the cost and potential for each trade. Please remember that all calculations of the percent cost of portfolio are based upon a $100,000 equity portfolio. If you have an equity portfolio of $400,000 you will need to increase the number of contracts by a factor of four. Also, the hedge amount provided is predicated upon a 30 percent drop in equities during an economic recession and owning eight hedge positions that provide protection that approximates $30,000 for each $100,000 of equities. So, you should pick eight candidates from the list and make sure that the hedge amounts total to about $30,000. Since each option represents 100 shares of the underlying stock, we cannot be extremely precise, but we can get very close. Another precaution: do not try to use this hedge strategy for the fixed income portion of your portfolio. If the total value of your portfolio is $400,000, but $100,000 of that is in bonds or preferred stocks, use this strategy to hedge against the remaining $300,000 of stocks held in the portfolio (assuming that is all that is left). This is also not meant to hedge against other assets such as real estate, collectibles or precious metals. Goodyear Tire & Rubber (NASDAQ: GT ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $25.43 $8.00 $15.00 $0.10 $0.65 $0.26 2592 $4,044 0.16% GT stock is actually slightly lower than it was at the time of the last update. But the potential gain is better if you can get in near the latest premium paid. Truck and SUV sales in the U.S. are improving due to lower gas prices, but sales of sedans and economy autos are dropping. Total sales for autos should be relatively flat with profits rising from a higher margin mix. But volume is likely to fall and that spells reduced sales for tire companies like GT. I don’t expect a major drop in share price without a recession, but we could see some gradual downside movement over the coming months. You will still need six January 2016 GT put option contract, but the cost drops significantly to cover one eighth of a $100,000 equity portfolio. Seagate Technology (NASDAQ: STX ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $64.59 $24.00 $45.00 $0.53 $0.57 $0.54 3789 $4,092 0.11% We will need a total of two June 2015 STX put options with a strike of $45 to complete this position at current pricing levels for each $100,000 in portfolio value. The actual last premium was listed as $0.47 which is below the bid premium. That is not likely to happen, so I split the difference between the bid and ask price to get $0.54 and used that for the calculations. The cost per month is considerably lower using June options than using January 2016 options. CarMax (NYSE: KMX ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $63.42 $16.00 $35.00 $0.45 $0.65 $0.60 3067 $3,680 0.12% We will need two January 2016 KMX put options with a strike of $35 to complete this position for each $100,000 in portfolio value. Royal Caribbean Cruises (NYSE: RCL ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $81.94 $22.00 $57.50 $0.85 $0.96 $0.91 3801 $3,459 0.09% We need only one June 2015 RCL put option contract to fill this position and protect against approximately $3,459 in loss on a $100,000 portfolio. United Continental Holdings (NYSE: UAL ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $64.05 $18.00 $35.00 $0.29 $0.64 $0.46 3596 $3,308 0.09% We need two June 2015 UAL put option contracts to fill this position and protect against approximately $3,308 in loss on a $100,000 portfolio. Currently the June contracts are more cost effective than the January 2015 contracts. L Brands (NYSE: LB ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $82.12 $20.00 $50.00 $0.80 $1.00 $0.85 3429 $5,830 0.17% We need two January 2016 LB put options to provide the indicated loss coverage for each $100,000 in portfolio value. Those of you who have been following the series will notice that I have increased the strike price from $40 to $50 here resulting in a significant rise in the amount hedged. Marriott International (NASDAQ: MAR ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $76.57 $30.00 $50.00 $1.00 $1.20 $0.95 1718 $3,780 0.22% We need two January 2016 MAR put option contracts to provide the indicated loss coverage for each $100,000 in portfolio value. Since the last premium was below the bid I chose to split the difference between the bid and ask premium and used $1.10 as the premium for the calculations. Micron Technology (NASDAQ: MU ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $30.05 $10.00 $17.00 $0.53 $0.59 $0.55 1173 $3,870 0.33% We need six January 2016 MU put option contracts to provide the indicated loss coverage for each $100,000 in portfolio value. The cost of these contracts is coming down slowly because the stock price has fallen since the last update. I will probably not add much, if any, of this candidate to my hedge unless I can get a better premium in the future Williams-Sonoma (NYSE: WSM ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $76.99 $20.00 $55.00 $1.40 $1.90 $1.43 2348 $3,357 0.14% We need only one January 2016 WSM put option contract to provide the indicated loss coverage for each $100,000 in portfolio value. In the last update article I used May options. Since then the pricing in the January contracts has become more favorable. Level 3 Communications (NYSE: LVLT ) Current Price Target Price Strike Price Bid Premium Ask Premium Last Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $47.88 $15.00 $40.00 $1.15 $1.35 $1.20 1983 $4,760 0.24% The position shown above would require two June 2015 LVLT put option contracts to provide the indicated loss coverage for each $100,000 in portfolio value. Remember that these options expire in June 2015 and will require us to replace them at additional cost. Even though the cost has come down by almost a third, I do not intend to add LVLT contracts at this time. I will wait for better pricing or use another candidate for my hedge. Morgan Stanley (NYSE: MS ) and Sotheby’s (NYSE: BID ) option costs are still too high to be considered at this time. I plan to wait for better entry points before adding to my hedge position with these candidates. Summary My top eight choices from the list above includes LB, KMX, GT, WSM, MAR, RCL, STX and UAL. That group (using the put option contracts suggested above) should provide approximately $31,550 in downside protection against a 30 percent market correction at a cost of 1.1 percent of a $100,000 portfolio. Granted, four of the candidates will need to be replaced by May or June which will add to the total cost, but we should still be able to keep the total hedge cost below two percent for the year. Brief Discussion of Risks If an investor decides to employ this hedge strategy, each individual needs to do some additional due diligence to identify which candidates they wish to use and which contracts are best suited for their respective risk tolerance. I do not always choose the option contract with the highest possible gain or the lowest cost. I should also point out that in many cases I will own several different contracts with different strikes on one company. I do so because as the strike rises the hedge kicks in sooner, but I buy a mix to keep the overall cost down. My goal is to commit approximately two percent (but up to three percent, if necessary) of my portfolio value to this hedge per year. If we need to roll positions before expiration there will be additional costs involved, so I try to hold down costs for each round that is necessary. I do not expect to need to roll positions more than once, if that, before we see the benefit of this strategy work. I want to discuss risk for a moment now. Obviously, if the market continues higher beyond January 2016 all of our new option contracts could expire worthless. I have never found insurance offered for free. We could lose all of our initial premiums paid plus commissions. If I expected that to happen I would not be using the strategy myself. But it is one of the potential outcomes and readers should be aware of it. And if that happens, I will initiate another round of put options for expiration beyond January 2016, using from up to three percent of my portfolio to hedge for another year. The longer the bull maintains control of the market the more the insurance will cost me. But I will not be worrying about the next crash. Peace of mind has a cost. I just like to keep it as low as possible. Because of the uncertainty in terms of how much longer this bull market can be sustained and the potential risk versus reward potential of hedging versus not hedging, it is my preference to risk a small percentage of my principal (perhaps as much as three percent per year) to insure against losing a much larger portion of my capital (30 to 50 percent). But this is a decision that each investor needs to make for themselves. I do not commit more than five percent of my portfolio value to an initial hedge strategy position and have never committed more than ten percent to such a strategy in total before a major market downturn has occurred. The ten percent rule may come into play when a bull market continues much longer than expected (like three years instead of 18 months). And when the bull continues for longer than is supported by the fundamentals, the bear that follows is usually deeper than it otherwise would have been. In other words, I expect a much less powerful bear market if one begins early in 2015; but if the bull can sustain itself into late 2015 or beyond, I would expect the next bear market to be more like the last two. If I am right, protecting a portfolio becomes ever more important as the bull market continues. As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other’s experience and knowledge. Additional disclosure: I hold put option positions in each of the stocks listed in the article.