Don't Sell -- Hedge In May and Go Away
|Apple last year was a terrific example of selling in May -- but only if bought again in June.|
The 2007 and 2008 SPY charts make a convincing argument that indeed only fools hold stocks beyond May. Ignoring dividends earned, Investors buying SPY at the close of May 2007 have been underwater since January 2008. Unfortunately, dividends are not enough to push buyers over the top and realize a gain. On the other hand, even though diving off a cliff following May 2008, SPY has already recovered. We all want to believe we will correctly time the next market drop, but most are unable to consistently.
Apple last year was a terrific example of selling in May -- but only if bought again in June. Apple's price did close June down from May. Unfortunately, absent a subsequent repurchase, sitting out of Apple results in watching a 60% price rise without you. Again, most astute investors will leave precision timing to active traders.
Sirius last year provided our best example for selling in May. Sirius' price at the end of May 2011 was $2.35, just off a recent 52-week high made in the same month. No monthly closing price has been higher, and the May high remains the highest price paid since. Travel back one or two years (but not three) and once again an impressive run is missed; further proof how difficult timing entries and exits may be. (Oliver Pursche wrote an intriguing sell in May article explaining why this may be the wrong year to "go away in May.")
Timing a stock or the market is no easy task. Tempting as liquidating stocks into cash is in today's market environment, another solution uses option hedges. Investors can sell covered calls against their shares to protect against a fall in prices, while not totally missing out if their stocks move higher.
Instead of selling SPY today for, at the time of writing, $131.53, an investor can sell the August $125 strike call for $9.50. If SPY moves lower during the summer doldrums, the call option will protect the position for the first $9.50 lower. If SPY moves higher, another $3.47 is added for a 2.6% improvement in return yield. If SPY trades flat through the entire summer, a covered call is still advantageous compared with selling.