Profits from Bear Side Speculation on Long Term Portfolios
Investors who developed long-term portfolios to take care of their retirement income purposes etc. can try to speculate on the bearish trend in the market and make some extra money without disturbing the portfolio they wish to accumulate for their retirement.
Authors
The strategy
Investors who developed long-term portfolios to take care of their retirement income purposes etc. can try to speculate on the bearish trend in the market and make some extra money without disturbing the portfolio they wish to accumulate for their retirement.
A completely passive portfolio management is to buy and hold for the long term. It is a sensible strategy for many busy professionals. Their professional responsibility does not give them enought time to take of their personal issues and family issues. They may not be able to spare time for trading in the stock market. One need not demand that they do it.
But there can be people who have some time to do limited amount of trading. In this bear trend trading, the contrarian position is taken by the investor. The contrarian position [Reilly and Brown] in the stock market advocates that returns converge to historical mean returns. So in some periods there are returns higher than historical mean returns or expected returns based on capital asset pricing model, they will be followed by return that are lower than mean returns. Theoretically one cannot say when it is going to happen. But it will happen. That is what some people say, in the stock market we can not predict timing and the event happening. It is more easy to predict events rather than timing.
A Numerical Example
So if the investor comes to a conclusion that historical mean return is say 15%, and if in any year there were return say more than 30%, a conclusion can be made that there may be downtrend waiting to come. The investor may say sell 10% of his portfolio. In concrete terms, say if he has Rupee ten lakh portfolio, he may sell Rupee one lakh. To make it still more specific, let us say NAV of mutual fund unit at the beginning of the year is Rs. 39 and at the end of the year it is Rs. 50.70. If in next three months, if the market goes down or retraces 10% of the 30% gain it made, the NAV of the unit will go down to 46.8. If the investor pays a 2% entry load the acquisition of price will be Rs. 47.74. The profit per unit in the transaction is 2.96. As units worth one lakhs are sold at the end of the year at the rate Rs.50.70, 1932 units are sold and bought back. The profit on these units will be Rs. 5846. This is clear profit to the investor which he can consume at that point in time. This profit was made without disturbing his passive portportolio. He can have the cake and eat it to.
Even though in the example it is shown for one year increase, one can think of implementing this strategy for two year large increases in prices instead of one year large increase in price.
People who adopted such strategies are finally happy in 2008, as the market levels all over the world are going close to or below 2003 levels. Even in India, slowly negative news is spreading, the sensex expected levels are plunging deeply day by day. All in the markets know that this bull run is an extraordinary bull run, but still it is getting devastated without any support emerging. So much smaller bull runs will always bear trend following them.
Writing Calls
Many passive portfolio holders implement bear side speculation by writing calls on their holdings. Writing calls gives commission and if the concerned share does not increase in price within the maturity period of the call, the investor retains the premium. Thus this premium is extra income on the portfolio.
Appplication to India at the Current Moment
Should somebody sell sensex now in the hope of 10 to 20% fall further. Yes, the case of such an action seems to be defensible as analysts are unable to call a bottom at this stage. But people who had done this when sensex was at 21,000 are laughing all ways in various directions including banks and mutual funds.
References
Reilly, Frank K. and Keith C Brown, Investment Analysis and Portfolio Management, 8th Ed. Chapter 16, Equity Portfolio Management Strategies, p. 619, Thomson South Western
No comments:
Post a Comment