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I received an email from a subscriber a couple of weeks ago with a link to my September 2007 newsletter titled “Hedging Your bets”. His email indicated that it might be time for a part deux. He is seeing a number of warning signs that I am as well. The big rush in IPO filings, the insider sell/buy ratio rocketing eight weeks ago to 186.8 right before the recent decline in the major indexes, bubble like valuations for some stocks that have long been a favorite of momentum investors, structural debt issues faced by PIIGS (Portugal, Ireland, Italy, Greece and Spain), a drop in existing home purchases and an increase in the unemployment rate just to name a few.
Warnings signs and negative news are part and parcel of the investing landscape and the market likes to climb a wall of worry. At some point the market will summit that wall and if it is overextended, it will revert to the mean. In simpler words, “what goes up, must come down”. In fact, as homeowners in the recent real estate bubble and speculators in the internet bubble came to find out, reversion to the mean does not simply imply that prices revert back to the long-term mean trend line but they often shoot well below that mean. This special report is dedicated to a hedging strategy that is specifically tailored to profiting from a sharp drop in individual stocks. I looked at over 60 years of S&P 500 data and generated some price variance graphs to see if this strategy could be applied to indexes but it turns out that it lends itself best to individual stocks.