What happens in a bear market?
Put credit spreads are neutral to bullish trades. What if a bear market occurs? Should I wait until after a correction to start trading Jim Fink's recommendations?
Market timing is a fool’s game, so Jim doesn’t play it. He favors bullish put credit spreads generally because the stock market rises two-thirds of the time and has averaged an annual real gain of 7% for more than 100 years. In the October 4, 2011 market briefing Jim discussed the long-term equity returns of the stock market and wrote:
Jim's Portfolio will always be net long equity exposure. In the short run, equity exposure can be unpleasant because stocks decline during bear markets and recessions. But keeping our focus on long-term wealth generation will pay off in the end. Market timing doesn’t work and will likely cause you to miss out on the largest equity returns. You need to stay in the equity game in order to fully benefit from the long-term wealth statistics mentioned above.
Options for Income and Velocity Trader are net long at all times, but they lose less money during bear markets than would a buy-and-hold stock portfolio because Jim sells put spreads at strike prices below a stock’s current market price. If Jim knew for certain that the market was going to drop, then of course his entire portfolio would be composed of bearish trades, but certainty doesn’t exist and therefore the best trading strategy is diversification — both in terms of directional bias and expiration month.
In Jim’s experience, bear markets are only identifiable after the 20%-plus damage has already been done. One method to avoid (not identify) market crashes is the simple 10-month moving average. If the stock indices close a calendar month below the 10-month moving average, risk has increased and more bear call spreads would be justified. An increased number of bear call spreads and/or reduced position sizes are okay “tilts” to express your market caution, but Jim will always have a portfolio consisting of a majority of bullish trades because historically betting on the market rising has generated the most wealth over time (by a long shot).
The key to successfully navigating a bear market is not to panic at the bottom but remain invested through the entire cycle — both down and back up. We can’t count the number of people who sold out at the market bottom in March 2009 and missed the entire ride back up to new all-time highs.