We added to a put position last week with the purchase of some out-of-the-moneys that expire in three weeks. This is a moderate longshot bet, since the S&Ps would need to fall by nearly 8% for the spread to go in-the-money. But the most we can lose at this point is $4 — that’s right, four dollars — with a chance to make as much as $10,000 if the S&Ps should drop by 10% or more. Not bad odds, really, and we may be able to improve on them if stocks drop only moderately next week. That would allow us to leg into vertical bears spreads with zero risk, or possibly even a guaranteed profit no matter what happens between now and October 21.
A Perpetual Motion Machine?
It’s undeniable that our bet goes against a global tide of digital money that is available to big borrowers in almost unlimited quantity and at rates approaching zero. Most recently, the money has continued to hold stocks buoyant near record levels, even though U.S. corporate earnings look like they will extend a string of declines for a sixth straight quarter. To some, it might seem like a kind of perpetual motion machine. For as we know, much of the buying is being done by companies who have used trillions in borrowed money, as well as otherwise useless cash of their own, to buy up their own shares. This has had the effect of raising earnings multiples without requiring any actual growth. Voila! Stocks rise, year-end bonuses fatten, warrants push above exercise prices and everyone is happy. In point of fact, however, no bear market has ever begun when ebullience similar to what investors must have been feeling on Friday, was not at a giddy crest. And while giddiness might not be particularly useful for precisely timing the onset of a bear market, it most surely justifies making cautious bets like the one described above.