As the bubble talk continues to prime economic meltdown scenarios, it would seem that vanilla stock options (American flavor, puts and calls, on standard expiration cycles) easily accessible to any US (or Internet) investment account holders provide a tidy way to short the market. But looks can be deceiving.

Assuming we all know our way around standard options, the shorting game would be played by buying puts and exercising them when the market falls.

The problems with this include (1) when the imbalance between buyers and sellers crosses a certain line, the markets close; you may not be able to exercise options you own at the moment you wish in a even a mild panic; (2) the standard expiration cycle on these options forces you to name the time at which the general market decline will be underway. So, if you foresee a decline in the markets within the next 9-12 months, that’s about as far out as standard options will take you - have at it and be prepared to lose your put payment if the decline comes later.

There are longer-term options, called LEAPS (Long-term Equity AnticiPation Security) that allow a put to be exercised up to 2.5 years out.

Not having experience with this particular derivative, I’m looking closely at them now; they seem to me to offer some reasonable way to hedge against a sudden market drop for reasonable sums of money. And unlike standard options, they allow more room for error in calculating when the bubble might burst. Here’s a scenario.

You don’t get protection against markets being closed altogether but otherwise this may be well worth your research time.

Is that a positive recommendation? Almost. I’ll let you know how my own research goes.

More meltdown investment explorations next week…

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This entry was posted on Saturday, June 25th, 2005 at 1:25 am and is filed under Investing. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.