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25% Allocation To Apple – Too Much Risk?

Summary Apple remains my largest position at 25.9%. The portfolio risk factor is not necessarily increased with position size. Reflect your knowledge or confidence in a company with your position size. After releasing the details of my Young and Cautious portfolio , one of the most frequently presented criticisms is of the very high allocation to Apple (NASDAQ: AAPL ). My current allocation is just north of 25%. Company Current p/e Current yield Annual dividends ($) Portfolio weighting (%) Apple 13 1.75 110.2 25.9 Aberdeen Asset Management ( OTCPK:ABDNF ) 10.53 5.21 130 9.6 Bank of America (NYSE: BAC ) 13.07 1.13 5.8 2 Coca-Cola (NYSE: KO ) 27.47 3.08 36.96 5 DaVita HealthCare (NYSE: DVA ) 33.16 0 0 11.6 General Motors (NYSE: GM ) 13.24 4 72 7.5 Gilead Sciences (NASDAQ: GILD ) 9.78 1.61 46.44 11.9 McDonald’s (NYSE: MCD ) 24.64 3.12 27.2 3.7 Rolls Royce ( OTCPK:RYCEY ) 8.28 4.18 62.42 7.5 Transocean (NYSE: RIG ) n/a 4 100.8 11 Wells Fargo (NYSE: WFC ) 13.51 2.7 27 4 Note: Average Yield = 2.6% The following comments sum up the main criticisms of the portfolio, which can be found in Young and Cautious – One month on and First Portfolio review – Young and Cautious , respectively. (click to enlarge) (click to enlarge) Although I respect the views of many commentators and contributors, I do not accept that the best strategy for an active investor is to just divide your capital equally among a list of companies that you think might perform well, regardless of their individual valuations and business circumstances. I will set out below why a higher allocation in a common stock does not necessarily lead to higher overall risk for your portfolio, and specifically, why I have allocated such a large percentage to Apple. Risk Risk can be split up into systematic risk and company specific risk, or non-systematic risk. However, for the purposes of this article, only company-specific risk will be analyzed. When talking solely about stocks, it is undeniable that non-systemic risk can be mitigated through splitting your capital among a variety of common stocks. This leads many investors to argue that the best way to reduce risk is to evenly distribute your capital over all your holdings. For example, 10 stocks with 10% weighting, or 20 stocks with 5% weighting. Many writers disagree on the ‘perfect number’ that provides the best risk/reward scenario for an active investor. Arguments generally range from 10 at the low end, to around 40 at the high end of the scale. Anything higher than this leads to a significant amount of money spent through transaction costs, which will impact significantly depending on how frequently positions are bought and sold. A higher number of stocks in a portfolio would most likely warrant the need to just take on a more passive approach through using a cheap index fund, such as provided by Vanguard. The risk that is not mentioned when talking about diversification Apart from individual company risk and systematic risk, one of the most prominent risks inherent in over-diversification is yourself. Your knowledge and time has to be spread over a higher number of companies, undeniably leading to the risk of gaps in your knowledge. This could be not having enough time to go through each company’s quarterly reports and individual valuations. This inefficient manner of investing has the potential to lead to sub-par returns. In addressing this view, investment icon Warren Buffett has stated: Once you decide that you are in the business of evaluating businesses, diversification is a terrible mistake to a certain degree. His reasoning is based on the idea of the mistake of omission in investing: Big opportunities in life have to be seized … Doing it on a small scale is almost as big a mistake as not doing it at all. This is not a scarcely held belief of prominent investors around the world. Below you see how frequently a large position plays a role in those investors’ portfolios: Warren Buffett Wells Fargo 19% Kraft Heinz (NASDAQ: KHC ) 18% David Einhorn Apple 20.5% Carl Icahn Icahn Enterprises (NASDAQ: IEP ) 27.5% Apple 21% Bill Ackman Valeant Pharmaceuticals (NYSE: VRX ) 25% Air Products & Chemicals (NYSE: APD ) 18.8% Chase Coleman Netflix (NASDAQ: NFLX ) 22.9% Amazon (NASDAQ: AMZN ) 20.1% Although not all of the companies have performed well over the past year, most notably Valeant Pharmaceuticals, most of them have. This high allocation in a company would classify as a ‘conviction buy’, exemplifying each investor’s confidence in these respective companies. It is what separates them from the rest of the market, allowing them the opportunity to beat the market returns. Know your strengths Every investor has their own strengths. This is down to the fact that whatever their profession is, or if they have a strong passion for something, they will generally have a deeper knowledge of it. This gives them an advantage over the general public and can give them the edge when it comes to putting their capital to work. This can be reflected in your portfolio. For example being a student has its perks. Many trends over what is popular originate from this age group. This could be said with regards to Apple, Facebook (NASDAQ: FB ) and Nike (NYSE: NKE ). What is popular with this age group has a tendency to spread to other age groups to create the norm. Looking back at Facebook, I grew up alongside the likes of Bebo, MSN Messenger and MySpace. My age group saw a shift from these social networking sites to Facebook, because we were causing the shift. Examples such as this give investors of certain age groups, professions, or hobbies that advantage in the market. This is one of the reasons why I am still so bullish on Apple. Regardless of what some financial news websites publish about Apple losing it’s ‘shine’ or ‘cool factor’, it is evident that Apple still has the backing of its supporters. It only takes a trip to any university library to see the momentous number of Apple products being used by students, who are in effect the future. For example, the Mac lineup has been of great popularity. Many students are making use of their university discounts and either upgrading from the previous model or other brand laptops. Growing up, these students will see Apple as the norm and are more likely to continue using their products. On the contrary, there are many areas where my knowledge lacks. This could come down to being young, lack of interest in the subject matter, or just plain ignorance. This is absolutely fine. It just means I don’t invest in these areas. If I invested in these areas for the sole reason of ‘achieving diversification’, I would be opening myself up to a great deal of risk. This is just not necessary. When opportunities are present, grab them by the horns The second part of investing in your strengths is investing at the right price. There are many companies I see doing well. Nike and Starbucks (NASDAQ: SBUX ) are both companies I want to own, just not at these prices. There is too much optimism built into the stocks. On the other hand, Apple is a company I understand well. I have a strong insight into how my generation sees their products and services over their competitors, and most importantly, the valuation is cheap. Valuation The company stands at a huge discount to the overall market. Apple’s trailing P/E ratio stands at just under 13 while the forward P/E is 11. This represents a 41% discount to the current ratio of the wider market, currently standing at 22. Apple is priced for a deceleration in earnings, while it is posting ever-growing earnings. The last earnings report showed EPS growth of 38% over the previous year, with guidance showing further record earnings for the near future. An earnings growth that surpasses the wider market. In addition to this, I believe Apple has in recent years been paving the way to become a future dividend champion. It is managing to consecutively increase dividend payments to shareholders year over year, while maintaining a low payout ratio. Currently, the dividends to shareholders represent only 21% of total earnings. This gives the company a great deal of room to increase payments several years from now. On top of this, Apple stated in April of this year that the share repurchase program would be increased to $140 billion. What are my risks? Having over a quarter of my capital in one stock does mean that if the share price drops significantly, this will drag down the portfolio significantly. Bill Ackman has recently been a victim of this, as Valeant has dropped like a rock after allegations of price gouging surfaced. This has led to him suffering a severe loss of capital and significant underperformance to the market. To compare this to Apple would be unfair. Apple has many factors that give it a large margin of safety to prevent this. First of all, almost a third of the entire market capitalization is made up of cash and equivalents, and this continues to grow. This allows Apple to raise cheap cash in corporate bonds to facilitate large share repurchases. Secondly, Apple’s great P/E discount to the wider market and higher growth rate provides a safety buffer, as it is already priced for no growth. The only time I will reduce this high allocation is if either of two things happen: Earnings begin to fall, or the share price rises resulting in a P/E ratio similar to the wider market. Conclusion Everyone has their strengths in investing. This means having a high allocation of your capital in one company will carry different risks depending on who owns that particular company. When you have the opportunity to own a good company trading at a cheap valuation that you have a deep understanding of, allocate more capital to this to increase your chances of outperforming the rest of the market. Thank you for reading. If you have enjoyed reading this article, or want to follow the progress of the ‘Young and Cautious’ portfolio please hit ‘follow’ at the top of the page. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Coming Prices In Sector ETFs: Compared By Market-Makers

Summary Behavioral Analysis of the players moving big blocks of securities in and out of $-Billion portfolios provides insights into their expectations for price changes in coming months. Portfolio Managers have delved deeply into the fundamentals urging shifts in capital allocations; now they take actions on their private, unpublished conclusions. These block transactions reveal why. Multi-$Million trades strain market capacity, require temporary capital liquidity facilitation and negotiating help, but are necessary to accomplish significant asset reallocations in big-$ funds. Market-making firms provide that assistance, but only when they can sidestep risks involved by hedge deals intricately designed to transfer exposures to willing (at a price) speculators. Analysis of the prices paid and deal structures involved tell how far coming securities prices are likely to range. Those prospects, good and bad, can be directly compared. This is a Behavioral Analysis of Informed Expectations It follows a rational examination of what experienced, well-informed, highly-motivated professionals normally do, acting in their own best interests. It pits knowledgeable judgments of probable risks during bounded time periods against likely rewards of price changes, both up and down. It involves the skillful arbitrage of contracts demanding specific performances under defined circumstances. Ones traded in regulated markets for derivative securities, usually involving operational and/or financial leverage. The skill sets required for successful practice of these arts are not quickly or easily learned. The conduct of required practices are not widely allowed or casually granted. It makes good economic sense to contract-out the capabilities involved to those high up on the learning curve and reliability scale. It requires, from all parties involved, trust, but verification. What results is a communal judgment about the likely boundaries of price change during defined periods of future time. Those judgments get hammered out in markets between buyers and sellers of risk and of reward. The questions being answered are no longer “Why” buy or sell the subject, but “What Price” makes sense to pay or receive. All involved have their views; the associated hedge agreements translate possibilities into enforceable realities. We simply translate the realities into specific price ranges. Then the risk and benefit possibilities can be compared on common footings. A history of what has followed prior similar implied forecasts may provide further qualitative flavor to belief and influence of the forecasts. Certainty is a rare outcome. Subjects of this analysis We look to some 30 ETFs with holdings concentrated in stocks of economic sectors. They provide a wide array of interests and an opportunity to see comparisons being made of expectations for price change on common footings. Please see Figure 1. Figure 1 (click to enlarge) Market liquidity is addressed in the first four columns of Figure 1. What leaps out is the huge capital commitment made, apparently by individual investors, in several of the Vanguard ETFs. At their typical average daily volume of trading, less than half a million shares, in many cases it would take over 100 days for all investors to escape a change in outlook. The trade-spread cost to trade these ETFs is typically in single basis points of hundredths of a percent. That is in the same region of a $7 commission on a $10,000 trade ticket. Price-earnings ratios for these subjects range from 15 times earnings to 22 times. But appear to be of little influence in differentiating between their selection for portfolio participation. Where behavioral analysis contributes Investor preferences among these ETFs during the past year are indicated in the last two columns of Figure 1, reflecting on their price range experiences in that period, shown in the prior two columns. The SPDR Metals & Mining ETF (NYSEARCA: XME ), fluctuated the most, by 133% low to high, while the SPDR Consumer Staples ETF (NYSEARCA: XLP ) traveled by only 17%. The difference is mainly a substantial loss in gold stocks, compared to capital perceived to be risk-exposed fled to a defensive grouping. From a portfolio management viewpoint, what matters most is where holdings are priced now, compared with where their prices may go in coming months. Prices are, after all, what determine the progress of wealth-building, and are what can be a source of expenditure provision as an alternative to interest or dividend income. Ultimately price changes are the principal portfolio performance score-keeping agent. Where prices are now, in comparison to where they have been provides perspective as to what may be coming next. If prices are high in their past year’s range, for them to go higher means that their surroundings must also increase. If price is low relative to prior year scope, a price increase represents recovery, when and if it happens. As you think about the security’s environment, does it seem likely in coming months to be one of stability, of increase, or of possible decline? How would such change be likely to impact the security under consideration? First there is a need to be aware of what has recently been going on. The measure for that is the 52-week Range Index. The 52 week RI tells what proportion of the price range of the last 52 weeks is below the present price. A strong, rising investment likely will have a large part of its past-year price range under where it is now. Something above 50, the mid-point pf the range is likely, all the way up into the 90’s. At the top of its year’s experience the 52wRI will be 100. At the bottom the 52wRI will be zero. For XME at a 52wRI of 3, the damages during the past year continue to be evident at this point in time. For XLP a 52wRI of 75 reflects the supportive influence of buying up to the present. The ratio of 3x as much downside as upside prospective price change is not that concerning to many if next year’s sector price behavior is like the recent year. After all, 3/4ths of 17% is only about -12%. That’s far better than 3/4ths of a range in the Vanguard Health Care ETF (NYSEARCA: VHT ) where the 52wRI of 77 comes up against a range of 60%, or minus 45% All the 52wRI can do is provide perspective. A look to the future requires a forecast. With that, expressed in terms of prospective price changes, both up and down, a forecast Range Index, 4cRI or just RI, gives a sense of the balance between upcoming reward and risk. The historical 52wRI can’t do much more than frame the past, a reference that may produce poor guidance. Knowledgeable forecasting is what behavioral analysis of the actions of large investment organizations, dealing with the professional market-making community, can do. The process of making possible changes of focus for sizable chunks of capital produces the careful thinking of likely coming prices that lies behind such forecasts. Hedging-implied price range forecasts Figure 2 tells what the professional hedging activities of the market-makers imply for price range extremes of the symbols of Figure 1, in the same sequence. Columns 2 through 5 are forecast or current data, the remaining columns are historical records of market behavior subsequent to prior instances of forecasts like those of the present. Figure 2 (click to enlarge) A lot of information is contained here, much of potential importance. Some study is deserved. Exactly the same evaluation process is used to derive the price range forecasts in columns 2 and 3 for all the Indexes and ETFs, regardless of leverage or inversion. Column 7’s values are what determine the specifics of columns 6 and 8-15. Each security’s row may present quite different prior conditions from other rows, but that is what is needed in order to make meaningful comparisons between the ETFs today for their appropriate potential future actions. Column 7 tells what balance exists between the prospects for upside price change and downside price change in the forecasts of columns 2 and 3 relative to column 4. The Range Index numbers in column 7 tells of the whole price range between each row of columns 2 and 3, what percentage lies between column 3 and 4. What part of the forecast price range is below the current market quote. That proportion is used to identify similar prior forecasts made in the past 5 years’ market days, counted in column 12. Those prior forecasts produce the histories displayed in the remaining columns. Of most basic interest to all investment considerations is the tradeoff between RISK and REWARD. Column 5 calculates the reward prospect as the upside percentage price change limit of column 2 above column 4. Proper appraisal of RISK requires recognition that it is not a static condition, but is of variable threat, depending on its surroundings. When the risk tree falls in an empty forest of a portfolio not containing that holding, you have no hearing of it, no concern. It is only the period when the subject security is in the portfolio that there is a risk exposure. So we look at each subject security’s price drawdown experiences during prior periods of similar Range Index holdings. And we look for the worst (most extreme) drawdowns, because that is when investors are most likely to accept a loss by selling out, rather than holding on for a recovery and for the higher price objective that induced the investment originally. Columns 5 and 6 are side by side not of an accident. While not the only consideration in investing, this is an important place to start when making comparisons between alternative investment choices. To that end, a picture comparison of these Index and ETF current Risk~Reward tradeoffs is instructive. Please see Figure 3. Figure 3 (used with permission) In this map the dotted diagonal line marks the points where upside price change Prospect (green horizontal scale) equals typical maximum price drawdown Experiences (red vertical scale). Of considerable interest is that the subjects all tend to cluster loosely about that watershed. This strongly suggests that the overall market environment is neither dangerously overpriced or strongly depressed in price, confirmed by the SPDR S&P 500 ETF (NYSEARCA: SPY ) at [9]. The high-return, high-risk group is the previously noted, price-depressed XME metals sector at [8]. Precious metals may rebound or they may get worse; no clear indication seems present from this analysis. Numerous low-risk, low-return alternatives are offered at [11] and [16], with symbols offered in the blue field at right. VHT, the previously compared historical risk(?) alternative to XLP, now demonstrates the fallacy of driving the portfolio car by sole use of the rear-view mirror. Earlier a possibility of -45% downside exposure was intimated. Current appraisals of VHT in [11] and Figure 2’s columns (5) and (6) show an upside price change prospect of +4.4% and experienced worst-case price drawdowns of only -2.7%. Clearly, big-money is not scared of losing much of the past gains. They may be influenced by the knowledge that 88% of forecasts like today’s have wound up as profitable holdings over the next 3 months. Typically those net gains were achieved in about 5 weeks for a +37% CAGR. Compared to the market proxy ETF, SPY, the clearest advantage seen in Figure 3 is [17], the SPDR Retail ETF, with an upside of +8.7% and price drawdowns of less than -3%. The bottom blue row of Figure 2, included for such comparison purposes shows SPY with an upside of almost +7% and downside experiences of -4.5%. The other blue comparison rows of Figure 2 provide perspectives in terms of an average of all the 28 sector ETFs above, then an average of the day’s 20 best-ranked stocks and ETFs, using an odds-weighted Risk~Reward scale, and then the overall population averages of over 2,000 securities. This kind of comparing between alternative investments is what often distinguishes the experienced investor from the neophyte. There are so many intriguing possible stories of investment bonanzas that it may be difficult to keep focus. And for the newbie investor deciding on what combinations of attributes may be most important is a daunting challenge. An advantage of the behavioral analysis approach is that price prospects suggested by fundamental and competitive analysis are being vetted by experienced, well-informed market professionals on both sides of the trade. Looking back at figure 2, there is a condition that may disrupt the organized notions drawn from Figure 3. Column 8 tells what proportion of the prior similar forecasts persevered in recovering from those worst-case drawdowns, and for the resolute holder turned into profitable outcomes, often reaching their targeted price objectives. Batting averages of 7 out of 8 and 9 out of 10 are quite possible to accomplish by active investors. Column 10 tells how large the payoffs were, not only of the recoveries, but including the losses. And those gains, in comparison with the forecast promises of column 5 offer a measure of the credibility of the forecast. There will be circumstances where credibility will be low and recovery odds worse than 50-50. When such conditions appear pervasive, cash is a low-risk temporary investment, sometimes the treasured resource. Conclusion At present there is no outstanding sector ETF choice for asset allocation emphasis or the commitment of new capital. Neither is there grave concern for dangerous outcome from present sector positions. The SPDR Energy Sector ETF (NYSEARCA: XLE ) shows the most downside exposure as experienced by prior like forecasts, and recent history suggests that its problems may not yet be over. Active investors may find attraction in the higher-ranked (by figure 2’s column 15) sector ETFS sufficient to consider shifts of some capital from XLE to other health care or information technology ETFs.

The Time To Hedge Is Now! November 2015 Update – Part II

Summary Brief overview of the series. Why I hedge. What to do with open positions expiring in January 2016. List of favorite candidates to consider now. Discussion of the risks inherent to this strategy versus not being hedged. Back to November Update Strategy Overview I could not include all the moves and results that I wanted to in the original November Update article due to length, so I am continuing with Part II. For new readers I have not changed the overview or why I hedge sections, so returnees from Part I can skip through those sections to save time. If you are new to this series you will likely find it useful to refer back to the original articles, all of which are listed with links in this instablog . It may be more difficult to follow the logic without reading Parts I, II and IV. In the Part I of this series I provided an overview of a strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works and gave the first two candidate companies to choose from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how it can help grow both capital and income over the long term. Part III provided a basic tutorial on options. Part IV explained my process for selecting options and Part V explained why I do not use ETFs for hedging. Parts VI through IX primarily provide additional candidates for use in the strategy. Part X explains my rules that guide my exit strategy. All of the above articles include varying views that I consider to be worthy of contemplation regarding possible triggers that could lead to another sizable market correction. I want to make it very clear that I am NOT predicting a market crash. I just like being more cautious at these lofty levels. Bear markets are a part of investing in equities, plain and simple. I like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then I like to hold onto to those investments unless the fundamental reasons for which I bought them in the first place changes. Investing long term works! I just want to reduce the occasional pain inflicted by bear markets. Why I Hedge If the market (and your portfolio) drops by 50 percent, you will need to double your assets from the new lower level just to get back to even. I prefer to avoid such pain. If the market drops by 50 percent and I only lose 20 percent (but keep collecting my dividends all the while) I only need a gain of 25 percent to get back to even. That is much easier than a double. Trust me, I have done it both ways and losing less puts me way ahead of the crowd when the dust settles. I may need a little lead to keep up because I refrain from taking on as much risk as most investors do, but avoiding huge losses and patience are the two main keys to long-term successful investing. If you are not investing long term you are trading. And if you are trading, your investing activities, in my humble opinion, are more akin to gambling. I know. That is what I did when I was young. Once I got that urge out of my system I have done much better. I have fewer huge gains, but have also have eliminated the big losses. It makes a significantly positive difference in the end. A note specifically to those who still think that I am trying to “time the market” or who believe that I am throwing money away with this strategy. I am perfectly comfortable to keep spending 1.5 percent of my portfolio per year for five years, if that is what it takes. Over that five year period I will have paid a total insurance premium of as much as 7.5 percent of my portfolio (approximately 1.5 percent per year average, although my true average is less than one percent). If it takes five years beyond the point at which I began, so be it. The concept of insuring my exposure to risk is not a new concept. If I have to spend 7.5 percent over five years in order to avoid a loss of 30 percent or more I am perfectly comfortable with that. I view insurance, like hedging, as a necessary evil to avoid significant financial setbacks. From my point of view, those who do not hedge are trying to time the market. They intend to sell when the market turns but always buy the dips. While buying the dips is a sound strategy, it does not work well when the “dip” evolves into a full blown bear market. At that point the eternal bull finds himself catching the proverbial rain of falling knives as his/her portfolio tanks. Then panic sets in and the typical investor sells after they have already lost 25 percent or more of the value of their portfolio. This is one of the primary reasons why the typical retail investor underperforms the index. He/she is always trying to time the market. I, too, buy quality stocks on the dips, but I hold for the long term and hedge against disaster with my inexpensive hedging strategy. I do not pretend that mine is the only hedging strategy that will work, but offer it up as one way to take some of the worry out of investing. If you do not choose to use my strategy that is fine, but please find a system to protect your holdings that you like and deploy it soon. I hope that this explanation helps clarify the difference between timing the market and a long-term, buy-and-hold position with a hedging strategy appropriately used only at the high end of a near-record bull market. What to do with Open Positions I want to start out by listing the remaining open positions that will expire in January 2016 and continue to retain some value of more than $0.10 to cover commissions should one consider selling. I will state here that I intend to hold all positions that are below that value as it makes more sense to let them expire worthless than to spend money to close positions. Those contracts that expire worthless, as in the past, are simply the cost of insuring a portfolio against potential loss. Insurance is never free. If the market takes a dive we can come back to reassess those positions if there is value created before expiration. The ask premium listed in the tables below is from when I recommended the purchase. The bid premiums listed are the current premiums available. Investors should do better than the listed prices on both ends but I prefer to use “worst case” examples to make things more believable. First off, I included CarMax (NYSE: KMX ) as it has some positions with value still remaining. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available April $55 $1.85 $2.10 $25 13% May $55 $1.40 $2.10 $70 50% June $57.50 $1.80 $3.20 $140 78% August $55 $3.10 $2.10 -$100 -32% September $50 $1.80 $0.75 -$1.05 -58% I intend to hold onto any of the positions I have in KMX and add contracts with future expirations when the cost is more in line with my strategy guidelines. I did add a position in KMX in October with some April put options with a strike at $40 which are under water and I intend to hold those as a fill position as I wait for better premiums and open interest/volumes on contracts that expire later. Next, we have Marriott International (NASDAQ: MAR ) which has a few contracts that still retain value. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available April $55 $0.80 $0.15 -$65 -81% June $65 $1.75 $1.05 -$70 -40% August $62.50 $1.45 $0.70 -$75 -52% August $60 $1.75 $0.50 -$125 -71% September $62.50 $1.75 $0.70 -$105 -60% I will continue to hold all MAR positions until I have the opportunity to replace the protection with more favorable entry positions with expirations further out. I did add some April MAR put options in October with a strike of $65 which are currently trading at about $2.25 where I originally bought them. I will hold this position. I only have two open positions in Veeco Instruments (NASDAQ: VECO ). Month of purchase Strike Price Ask Premium at purchase Current Last Premium $ Gain Available per contract Percent Gain Available May $20 $0.90 $1.40 $50 55% June $20 $0.40 $1.40 $100 250% I will continue to hold VECO put options as this stock has already fallen from the mid-30 dollar range when I first identified it as a candidate last April to the current price of $19.77 (as of the close on Wednesday, November 18, 2015). There may still be some more gain to capture before the January 2016 expiration. However, these shares have already fallen so much that the strategy will no longer work well for adding new positions in the future. I still hold several positions in L Brands (NYSE: LB ) put options dating back to December. There are six positions listed in previous articles that still have a value of over $0.10. All positions in LB currently show losses. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available April $65.50 $1.10 $0.15 -$95 -86% May $70.50 $1.85 $0.25 -$160 -86% June $72 $1.45 $0.30 -$115 -79% August $70.50 $1.50 $0.25 -$125 -83% August $70.50 $2.20 $0.25 -$195 -87% September $78 $1.80 $0.70 -$85 -47% I intend to continue holding all open positions I have in LB. LB has some premium brands that may suffer during a recession. That is why I believe the stock fared so poorly in the last two recessions. I will continue to use LB in the future. Morgan Stanley (NYSE: MS ) has had mixed results, mostly losses, so far. I have five open January put option positions in MS from previous articles with values above $0.10. I do not own all recommended contracts, but do own some contracts of each candidate listed in my articles. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available May $28 $0.44 $0.15 -$29 -70% June $34 $0.92 $1.27 $35 38% August $35 $0.96 $1.72 $76 79% August $28 $0.71 $0.15 -$56 -79% September $27 $0.62 $0.10 -$52 -84% I also hold an open position from October in the April 2016 MS put options with a strike of $25. I intend to hold all positions in MS and add more in the future. Level 3 Communications (NYSE: LVLT ) was down over 21 percent in August while the S&P 500 fell about ten percent. This is an example of what can happen to the candidates I use. I only have one open position in LVLT with a value remaining of over $0.10. This is another example of the volatility of this stock. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available June $42 $0.90 $0.15 -$75 -83% The LVLT position could be positive again with another market swoon. I will continue to hold my positions in LVLT and intend to continue to use it in the future. The only concern I have with this one is the lack of active trading in the options. I only list a contract that has open interest of more than 50 contracts and prefer more than 100. Many of the LVLT contracts have too few contracts open to consider. Tempur Sealy (NYSE: TPX ) share price continues to surge to near record levels. This is actually good for us in terms of future hedging. I have only three open positions with a remaining value above $0.10. The last price these options traded at is $0.50 but the last bid listed was at $0.25. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available August $60 $1.50 $0.25 -$125 -83% August $60 $1.70 $0.25 -$145 -85% September $60 $1.60 $0.25 -$135 -74% Again, this issue is likely to fall precipitously again when a recession occurs. I will hold my remaining positions and continue to use TPX in the hedging strategy. Royal Caribbean Cruise Lines (NYSE: RCL ) shares have continued to rise and are within about six percent of the high. I have not fared well with these positions yet, but when a recession hits this stock has a tendency to fall fast as consumers put vacation plans on hold or shop for deep discounts. Either one hurts RCL margins. I have only two open positions in January options for RCL that remain above $0.10. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available August $72.50 $1.65 $0.24 -$141 -85% August $70 $1.99 $0.18 -181 -91% I will continue to hold my RCL positions and add more in the future. This is insurance. I remain convinced that RCL will pay off big when we really need it. Coca-Cola Enterprises (NYSE: CCE ) initially fell right after I bought my first position. It had also fallen in previous short-term market corrections by much more than the overall indices. I have only one January option position in CCE open that is valued over $0.10. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available August $45 $1.06 $0.15 -$91 -86% I will hold my CCE positions and add more when the premiums are low enough on future contracts. United Continental (NYSE: UAL ) is one of the weakest remaining major airlines. Its rival, American (NASDAQ: AAL ), is also one to consider if you consider it as a better proxy. Make no mistake that these shares should plummet when a recession hits regardless of the cost of fuel. The shares have been struggling even with low fuel prices. Month of purchase Strike Price Ask Premium at purchase Current Bid Premium $ Gain Available per contract Percent Gain Available September $45 $1.39 $0.31 -$108 -78% I intend to hold my UAL positions and add more in the future. That concludes the summary of outstanding positions expiring in January and what I intend to do with each. List of favorite candidates I listed five candidates with my favorite option contract for each in Part I. E*TRADE Financial (NASDAQ: ETFC ), Goodyear Tire (NASDAQ: GT ), Morgan Stanley , and Royal Caribbean Cruise Lines all have slightly lower premiums available as of the close on Wednesday, November 18, 2015. A couple more day like yesterday and everything will be cheaper. Patience is always a key factor in investing. I start with a new candidate to get things rolling. Boyd Gaming has shown the propensity to fall faster than the overall market, not just in major crashes, but during the brief market declines as well. The share price fell significantly more than the rest of the market during the scares of 2011, 2013 and 2014. It was decimated during 2008-09. It is currently less than three percent off its high of the year and represents a good opportunity for entering a position on this upswing. Another recession could take this issue all the way back down to $5.00 per share. Boyd Gaming (NYSE: BYD ) Current Price Target Price Strike Price Bid Premium Ask Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $20.57 $5.00 $17.00 $0.40 $0.60 1,900 $3,420 0.18% I need three BYD March 2016 put option contracts to provide the indicated protection for a $100,000 portfolio. Masco Corporation (NYSE: MAS ) Current Price Target Price Strike Price Bid Premium Ask Premium Poss. % Gain Tot Est. $ Hedge % Cost of Portfolio $29.84 $15.00 $23.00 $0.20 $0.45 1,678 $3,775 0.225% MAS hit a new 52-week high on Wednesday. Its fortunes are highly correlated with construction and home improvements. A recession could clobber this business. I need five April 2016 put contracts as described above to provide the indicated protection for a $100,000 portfolio. Those are the only new candidates I want to add at this time. As I mentioned earlier in the article, I am hoping to find some more candidates and better entry prices in the future. I will be submitting articles each time I find something worth sharing. Summary As I pointed out in the article linked at the beginning of the precious article I believe that the market is at a crossroads. There is very little impetus to drive prices higher other than cheap money, but cheap money may be enough to keep things going a little longer. If a bear market does not show itself before January 2017 I will be surprised. Many stocks are already experiencing a “stealth” bear market and therefore I believe it is prudent to make prudent hedging decision for 2016. I would like to extend the expirations on contracts more than I have for more extended coverage but the open interest/volume is not yet high enough to wade into those contracts. That should change over the next few months and I will be ready to add more positions as it happens. That is one of the primary reasons why I have tried to emphasize that I am only adding partial positions at this time. That is also why I intend to hold current positions as a means of maintaining protection while we transition to new positions. Going forward I want to write more often about this strategy for two reasons. The first is simply that is seems the global economy is nearly ready to fall into a recession and growth in the U.S. also seems rather stagnant. If profits continue to fall year/year as happened in the third quarter it may portend the beginning of the next recession. Retail sales and profit margins may prove to be the most important measure of the health of the consumer and, by extension, the U.S. economy. The second reason is that I would like to publish whenever I see a good entry point in one of the candidates or when I identify another candidate immediately instead of waiting for a monthly update. I hope these changes will be beneficial to readers following the series. Brief Discussion of Risks If an investor decides to employ this hedge strategy, each individual needs to do some additional due diligence to identify which candidates they wish to use and which contracts are best suited for their respective risk tolerance. I do not always choose the option contract with the highest possible gain or the lowest cost. I should also point out that in many cases I will own several different contracts with different strikes on one company. I do so because as the strike rises the hedge kicks in sooner, but I buy a mix to keep the overall cost down. My goal is to commit approximately two percent (but up to three percent, if necessary) of my portfolio value to this hedge per year. If we need to roll positions before expiration there may be additional costs involved, so I try to hold down costs for each round that is necessary. My expectation is that this represents the last time we should need to roll positions before we see the benefit of this strategy work more fully. We have been fortunate enough this past year to have ample gains to cover our hedge costs for the next year. The previous year we were able to reduce the cost to below one percent due to gains taken. Thus, over the full 20 months since I began writing this series, our total cost to hedge has turned out to be less than one percent. I want to discuss risk for a moment now. Obviously, if the market continues higher beyond January 2016 all of our old January expiration option contracts that we have open could expire worthless. I have never found insurance offered for free. We could lose all of our initial premiums paid plus commissions, except for those gains we have already collected. If I expected that to happen I would not be using the strategy myself. But it is one of the potential outcomes and readers should be aware of it. I have already begun to initiate another round of put options for expiration beyond January 2016, using up to two percent of my portfolio (fully offset this year by realized gains) to hedge for another year. The longer the bulls maintain control of the market the more the insurance is likely to cost me. But I will not be worrying about the next crash. Peace of mind has a cost. I just like to keep it as low as possible. Because of the uncertainty in terms of how much longer this bull market can be sustained and the potential risk versus reward potential of hedging versus not hedging, it is my preference to risk a small percentage of my principal (perhaps as much as two percent per year) to insure against losing a much larger portion of my capital (30 to 50 percent). But this is a decision that each investor needs to make for themselves. I do not commit more than three percent of my portfolio value to an initial hedge strategy position and have never committed more than ten percent to such a strategy in total before a major market downturn has occurred. The ten percent rule may come into play when a bull market continues much longer than expected (like three years instead of 18 months). And when the bull continues for longer than is supported by the fundamentals, the bear that follows is usually deeper than it otherwise would have been. In other words, at this point I would expect the next bear market to be more like the last two, especially if the market continues higher through all of 2016. Anything is possible but if I am right, protecting a portfolio becomes ever more important as the bull market continues. As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other’s experience and knowledge.