We could be in for a wild ride this week! A Fed interest rate hike has the potential to seriously shock investors. The Dow recently fell 400 points at the simple prospect of a rate hike. The odds of this September rate hike stand at 11%, according to experts [marketwatch.com]. The federal funds rate represents the interest rate at which banks and credit unions lend money to one another overnight. This rate determines all other interest rates in the economy. Overall, the higher this rate, the more expensive it is to borrow money. For more specifics on the federal funds rate see the attached link here: investopedia.com
During the 2008/2009 recession interest rates were slashed in an effort to prop up the U.S. economy. It’s now been eight years and rates are still near zero. So, for almost a decade, businesses have been borrowing cheap money. As I’ve continually discussed this could be a recipe for disaster. We may be in a very large stock market bubble fueled by low interest rates. When the Federal Reserve finally decides to raises rates again we could see a major correction, possibly even a recession.
Image by investmentnews.com].
That being said, I’m still exploring options trading in an effort to “insure” my securities against hefty losses. The paperwork finally came through and I am ready to begin trading options. My only concern is the costs of such insurance. Those who are familiar with options understand how prices vary greatly on a day-to-day basis. I was looking at purchasing a put option for 100 shares of SPY at a strike price of $200. SPY is an S&P 500 ETF covering a wide variety of industries. Essentially, the market would need to go down more than 8% for my put option to be ‘in the money’. The more the price falls below the $200 strike price the more I could potentially earn.
At one point last week one contract for 100 shares at $200 cost only $171.00. The next day the market declined and the price of the option surged to $240+. The closer the contract is to the strike price the higher the cost. Therefore, I’ve found myself checking the options chain on a daily basis. It’s difficult for me to justify $250 for insurance. This insurance policy would only cover me until mid-November and the market would need to incur a major correction for me to simply break even. Fortunately, there is time value associated with options contracts. The contracts become less expensive the closer they get to expiration.
I did, however, implement a stop-loss on EXG. If the price falls to $8.30 Ameritrade will automatically sell the security. If there is a downturn my other securities should (hopefully) recover. Also, I still intend on purchasing the SPY put option to hedge against short term losses. Finally, I’ll be investing in safe securities able to weather an economic storm. I’m still considering gold, utilities, and even retail giants like Target. In the meantime we should be watching the Fed closely. Even in the event of a correction there is money to be made. Capitalizing on investor fears can be a great way to open up cheap positions in quality companies.
DISCLAIMER: I am not a licensed investment advisor or tax professional. I am not liable for any losses incurred by any parties. This blog should be viewed for entertainment and/or educational purposes only. Any transactions published are not recommendations to buy or sell any securities. Please consult with an investment professional before making investment decisions.