Buying the Dips Can Be Fatal—Unless You’re in It for the Long Term

Uncle Sugar, as soldiers have long referred to the U.S. government, has demonstrated once again that he will protect investors from their misplaced avarice.

After Silicon Valley Bank and Signature Bank all but imploded, the Federal Reserve, Treasury Department, and Federal Deposit Insurance Corp. united to protect the stock market from another systemic financial disaster that regulators failed to anticipate.

Volatility will always exist. This past week’s gyrations are proof. Long-term investors should celebrate that fact, especially since the government has become the great de-risker of markets.

Since 2000, Uncle Sugar has rescued investors so many times that it is logical to conclude that the greatest investment risk is not embracing risk. As the stock market plummeted and bond rates exhibited extraordinary volatility, legions of investors—we use the term in its most generous sense—sprung into action.

People with no special insight into investing, economics, and markets bought stocks and traded call and put options in various combinations in the hard-hit regional-bank sector. Those investors were initially rewarded: Many of the stocks bounced higher on news that the government would backstop banks.

Anyone who used zero-dated options—which expire in one day—probably made out handsomely. It is irrelevant, for now, that zero-dated options are modern reincarnations of the lower Manhattan bucket shops in the years before the 1929 crash. Then, as now, too many people were betting that stocks will rise or fall based on momentum patterns.

Let others moralize about markets and short-term greed. Instead, let’s focus on what is likely the greatest risk facing investors: always buying the dip.

The market mob has been conditioned by more than 20 years of Uncle Sugar de-risking every financial crisis into believing that investors can make money buying every dip. At some point, this misplaced faith will prove disastrous.

What to do? Become a disciplined investor. At a minimum, review your portfolio and try to reduce risk. Do you sleep soundly? If not, consider securing profits in more-speculative positions.

Long-term investors could consider what we have long called “time arbitrage.” This strategy takes advantage of short-term volatility by selling puts and calls and buying blue-chip stocks that can be warehoused for at least three to five years.

Options prices often inflate with fear and greed premiums during broad market gyrations. This reflexive reaction positions disciplined, long-term investors to profit from chaos and volatility.

The Cboe Volatility Index, or VIX, has spiked higher. Options on the S&P 500 index, and its component stocks, are now elevated. Investors can get paid for the risk of buying stocks.

We flagged the strategy back in early February, when we suggested that investors stop acting as if they had intimate knowledge of the stock market, which is unknowable. What is more knowable are a handful of blue-chip stocks that ideally pay dividends. Such stocks can often be kept for many years.

At some point, Uncle Sugar will be overcome by events, or OBE. When that happens, the dip buyers will be crushed.

It is hard to know when that might happen, but this is a fact. Bond market volatility is now extreme. The odds of a soft or hard economic landing are hard to determine. That should make everyone nervous.

What is the countermeasure to chaos and risk? Discipline.

–

Originally Posted March 16, 2023 – Buying the Dips Can Be Fatal—Unless You’re in It for the Long Term

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.