Managing Risk with Warrants, Options and Leaps

By: Dudley Baker | Thu, Mar 22, 2007
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Regardless of what the markets are currently doing, now, more than ever is the time to take action to protect your portfolio.

Over the last few weeks investors have been very very surprised at the performance of virtually all of the markets with the big initial shock coming from the 9% decline in the Shanghai markets overnight. Many analysts have had some great insight into what the problems are, the effects of them and how investors should approach the markets. Unfortunately, we have many different opinions from these analysts. While differing opinions are great to read it can and does create much doubt in the mind of the average investor. This is truly a time that you, the investor, must firmly believe in your investment philosophy or at a minimum attempt to protect yourself in the event you are wrong.

We personally follow many of the top analysts and also read as much as possible on websites for information and conflicting opinions. While, yes, we have our own opinions much is based upon the collective views of some of the top analysts in the world. When our favorites are not on the same path we attempt to evaluate the risk of our investments and how to manage this risk with long-term warrants, options or Leaps.

Recently Jim Rogers, who I like to refer to respectfully as Mr. Commodity, was quoted as, predicting "a real estate crash that would trigger defaults and spread contagion to emerging markets.....You cannot believe how bad it's going to get before it gets any better....It's going to be a disaster for many who don't have a clue about what happens when a real estate bubble pops....the crisis would spread to emerging markets which now faced a prolonged bear run....This is the end of the liquidity party....Some emerging markets will go down 80 percent, some will go down 50 percent....some will most probably collapse."

Dr. Marc Faber says, "most investors are heading for huge losses...but gold to outperform."

Richard Russell says, "....gold looks fine. Stop worrying."

Chris Laird speaks of a, "World Liquidity Crisis Emerging."

Another analyst writing on these websites which I respect is Adam Hamilton. Adam sees the possibility of a 2 year bear market in the equity markets similar to the 1973 - 1974 with a drop of approximately 45 - 50% in the Dow by the end of December 2008. On the other hand he sees gold, silver and the commodity sectors increasing as eventually the fear and the fleeing money in the equity markets will find a new home in the commodities. He sees this commodity cycle, by historical standards, as being only about half over with much more excitement to come.

Short-term we did have all markets recently going down together - equities, gold, silver, mining stocks, etc. This has now scared many precious metals investors into thinking that if the equity markets collapse, then so will gold, silver, and the mining shares. This we believe, however, will be only a short-term disconnect before the money goes into the commodity sectors.

A few of the mine fields in the investment arena today:

World Liquidity
Yen Carry Trade (and the unwinding thereof)
Derivative markets
U.S. Sub-Prime mortgage market
U.S. Dollar
U.S. Deficits
Iraq and Iran

Any of the above could bring down the entire house of cards as we know it today. Scary times? You bet. I personally suspect one day an event will occur in the derivative markets or with the unwinding of the Yen carry trade. These are areas of which the average investor has absolutely zero knowledge other than perhaps hearing the terms mentioned in the financial press or on CNBC. Think about it, investors would not even know what hit them nor be able to explain it. Like being hit by a truck and not even seeing it coming at you. At least it will be quick but the financial pain could easily last a lifetime if you are not properly positioned.

With the above gloomy backdrop, what is the level of risk you are willing to accept?

Remember as investors, each of us must make this decision each day in the financial markets. The decision of risk is ours and ours alone, not our brokers or advisors. The ultimate responsibility lies with each of us. At the end of the day, if our investments do not perform, we must take responsibility for the losses ourselves.

Should we as investors be concerned about unfolding events? Should we be fearful? Should we be running for the exits? Maybe all of the above are appropriate as this is surely a time for immediate reflection on our investments and the protection thereof.

Allow me to address briefly how two different classes of investors could address this financial dilemma:

1. If you are an investor still primarily investing in traditional equities and perhaps the emerging
markets:

Liquidate all your stocks or positions
Liquidate enough to be comfortable
Use Puts, i.e. Leaps on the Standard & Poor's 500 for downside protection
Invest in precious metals, the bullion, mining shares, long-term warrants, call options,
Leaps or ETF's on gold or silver.

2. If you are an investor heavily involved in the precious metals sector, mutual funds, mining
shares or long-term warrants:

Liquidate enough of your positions to be comfortable holding the cash in Euros
Increase exposure to the bullion or ETF's on gold or silver
Purchase Leap Puts on an index, i.e. Standard & Poor's 500 for downside protection

Will the current storms pass without incident? Perhaps, but financial well being and decision making are now front row center.

If you would like more information on options and leaps you should visit the Chicago Board Option Exchange. For information on long-term warrants (up to 5 years), we welcome you to visit our website.

For our subscribers of record as of this Sunday evening at 7:00 CST, we will be sending out our personal and specific plan for dealing with the management of risk.

 


 

Dudley Baker

Author: Dudley Baker

Dudley Pierce Baker
Founder/Editor - Guadalajara/Ajijic, Mexico
CommonStockWarrants.com
A Market Data Service for Warrants

Dudley Pierce Baker is the founder and editor of Common Stock Warrants and its predecessor, Precious Metals Warrants and a 1967 graduate of St. Mary’s University in San Antonio, Texas with a major in accounting.

Disclaimer/Disclosure Statement: CommonStockWarrants.com is not an investment advisor and any reference to specific securities does not constitute a recommendation thereof. The opinions expressed herein are the express personal opinions of Dudley Baker. Neither the information, nor the opinions expressed should be construed as a solicitation to buy any securities mentioned in this Service. Examples given are only intended to make investors aware of the potential rewards of investing in Warrants. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions involving stocks or Warrants.

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