This Will Not End Well

I was talking to a 67-year-old woman who is close to retirement and wanted me to review her financial portfolio. She has a money manager with a well-known full-service brokerage firm. She was upset because she lost $30,000 in the last month. When I looked at her portfolio, I was shocked. The money manager had her 100 percent in stocks. Whenever she asked him to reduce the allocation, he protested: “It’s not a real loss until you sell,” he told her. Hogwash.

To stop the bleeding, she finally got the courage to sell all her stocks and move into cash (i.e. money market) until she finds another financial manager. Good move. In a bear market, most stocks, even stocks of good companies, will sustain severe losses. The market might go down by 20 percent but many individual stocks will go down by 40 or 50 percent. This is not going to end well for millions of people who own individual stocks. If you’re close to retirement or retired, in my opinion, you should be reducing the number of stocks in your portfolio. 

How Options Can Save You from Disasters

By now, most investors and traders know what happened to LinkedIn (LNKD). After the company reported earnings, the stock plunged by 40%, smashing the portfolios of pros and amateurs alike. LinkedIn has a history of booms and busts after announcing earnings. In the future, before any stock announcement, there are two actions you might consider:

  1. If you are long a stock, you can buy short-term (weekly) put options for insurance. If the stock plunges (as happened in this case), the put options would reduce (but not eliminate) the pain. The downside is that puts on some volatile stocks are pricey, especially if you choose a long expiration date. 
  2. Instead of being exposed to a large and expensive stock position, replace the stock with call options before a major news announcement (assuming you are long the stock). With LNKD, although you would have lost the entire amount of the cost of the option, instead of losing a small fortune, you may have lost a small amount. Example: Instead of losing $8,000 with 100 shares, you might have lost $400, the total cost of the option. 

In a bear market, put options are your friend. Use them for protection or for speculation. For more information, read my book, Understanding Options 2E (McGraw-Hill).