It’s understandable to be concerned about your investment portfolio in an environment where the rate of change is significant (higher than your reference point). From a behavioral perspective, making a conscious decision to be proactive, as opposed to reactive, can be beneficial. The alternative can lead to selling out of the market at or near lows.
The Certified Financial Planning community uses a helpful visual to illustrate:
Source: CFP.net
One of many fascinating behavioral elements endemic to capital markets is the fact that people tend to be most excited to buy an ETF, equity, or other security at or near a top. They are also most likely to sell at or near a bottom.
There are few, if any, other consumer markets where we display similar behavior. For instance, I recently attended an in-person conference and needed a new pair of shoes. I had my eye on a specific brand and style. A week passed, and the shoes were discounted, plus I had a coupon — I ended up buying those shoes for roughly 30% less than when I first spotted them. I’m not alone in rejoicing when I find a deal like this; so why is it so hard for investors to see it the same way when it comes to investing?
In fairness, U.S. equity indexes could be further discounted. Furthermore, timing markets in the short term is difficult. In the long-term, it’s next to impossible. Translation: picking tops and bottoms consistently is a fool’s errand.
Insight
There’s incredible behavioral finance research available and it can change your perspective on (inevitable) market drawdowns. Daniel Kahneman’s Thinking Fast and Slow is an excellent starting point.
The author, with the help of Amos Tversky, earned a Nobel Prize for his research. There’s a point of emphasis on the two types of human thinking; referred to as System 1 and System 2. In brief, System 1 thinking is intuitive (fast, involuntary). System 1 is reactive. This ability keeps us functioning at a high level. We’re equipped to make 35,000 or more decisions a day. By contrast, System 2 thinking involves “complex computations and allocates attention to the mental activities that demand it.” System 2 is more proactive.
Daniel Kahneman would likely advocate for System 2 thinking when any capital allocation is considered. If a portfolio declines by 30%, our System 1 brain wants the pain to stop (quickly). The part of our minds capable of more deliberative analysis is necessary to fact check the more impulsive angle. The dichotomy between our “instinctual reaction” and our more reflective process is a challenge to reconcile.
In other words, we benefit from having a plan and sticking to it. In capital markets, call and put options afford end-users the ability to define their risk and potential reward (depending on the strategy) over a specific time frame. That’s powerful.
VOLQ Options
Nasdaq is excited to announce the launch of VOLQ options. The ecosystem that has grown up around the Nasdaq-100 over the past few decades is evolving. VOLQ options will enable market participants to express a view on forward NDX volatility and/or manage volatility (vega) risk.
VOLQ options can help market participants create a more “proactive” portfolio. The VOLQ Index and associated futures contracts exhibit a negative correlation to the Nasdaq 100® Index. Put more plainly, if the NDX declines, VOLQ would likely increase (and vice versa). In theory, owning VOLQ call options during a significant NDX decline could act as a P&L speedbump.
There’s undoubtedly nuance that needs to be understood before using VOLQ option strategies. Click here to learn more.
Looking Ahead
While past performance is not indicative of future results, the July trend is positive for the Nasdaq-100® Index. The charts below illustrate average monthly NDX returns since 2010 and then break out July performance by year. July is by far the standout from a monthly perspective. On average, between 2010 and 2021, the Nasdaq-100 Index has gained 4% during the month.
July NDX returns since 2010 have all been positive. Four of the 12 July returns have been greater than 6%. The “weakest” July (2014) yielded a much more modest 1.18% gain. Will July 2022 buck the trend?
Source: Bloomberg, Nasdaq
Big picture, volatility is a constant. Volatility is the source of future returns. Volatility is one of those words where the denotation and connotation are unique. Volatility is best understood when placed in perspective. Derivatives allow us to embrace change. To learn more about the Nasdaq-100 Index and its index options ecosystem, explore here.
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Originally Posted July 27, 2022 – Timing the Markets is a Fool’s Errand; What Investors Should Consider Instead
Disclosure: Nasdaq
Index
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Options
For the sake of simplicity, the examples included do not take into consideration commissions and other transaction fees, tax considerations, or margin requirements, which are factors that may significantly affect the economic consequences of a given strategy. An investor should review transaction costs, margin requirements and tax considerations with a broker and tax advisor before entering into any options strategy.
Options involve risk and are not suitable for everyone. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained from your broker, one of the exchanges or The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, IL 60606 or call 1-888-OPTIONS or visit www.888options.com.
Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and education purposes and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities.
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Disclosure: Interactive Brokers
Information posted on IBKR Campus that is provided by third-parties does NOT constitute a recommendation that you should contract for the services of that third party. Third-party participants who contribute to IBKR Campus 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 Nasdaq and is being posted with its permission. The views expressed in this material are solely those of the author and/or Nasdaq and Interactive Brokers 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 buy or sell any security. It should not be construed as research or investment advice or a recommendation to buy, sell or hold any security or commodity. 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.
Disclosure: Options Trading
Options involve risk and are not suitable for all investors. Multiple leg strategies, including spreads, will incur multiple commission charges. For more information read the “Characteristics and Risks of Standardized Options” also known as the options disclosure document (ODD) or visit ibkr.com/occ
