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Stocks Fell Off A Cliff in Late August - What To Do Now

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

September 1, 2015

IN THIS ISSUE:

1. 2Q GDP Came in Much Stronger Than Expected

2. Stocks Fall Off a Cliff in Late August – Now What?

3. Options 101: How to Use Them to Your Advantage

4. Introducing ZEGA Financial’s High Probability Options Strategy

5. Why Option Selling (Writing) Can Be So Attractive

Overview

What an absolutely CRAZY couple of weeks we’ve just been through! The collapse of stock prices around the world has stunned investors. By some measures, the plunge in the Dow and the S&P 500 in August was the worst in 75 years, even worse than the Crash of 1987. While I advised readers to reduce long-only equity exposure significantly in April and May, I was not expecting a 15% spike down in just a few trading sessions.

Later in today’s E-Letter, I will introduce you to the latest money manager to make it on to our recommended list. This money manager specializes in buying and selling options on stock index contracts. This is one of the more unusual strategies I have seen over the years, but when you see the results, you’ll understand why I’m so excited to add ZEGA Financial to our stable of recommended Advisors.

Before we get to the above issues, let me briefly comment on last Thursday’s better than expected report on 2Q Gross Domestic Product. 

2Q GDP Came in Much Stronger Than Expected

The Commerce Department released its second estimate of 2Q GDP showing surprising growth of 3.7% (annual rate), up from 2.3% in the first estimate in July, and well above the disappointing 0.6% in the 1Q. The latest number was considerably higher than the pre-report consensus of 3.1%-3.2%.

The report cited positive contributions from consumer spending, exports, state and local government spending and nonresidential fixed investment. The price index for gross domestic purchases, which measures prices paid by US residents, increased 1.5% (annual rate) in the 2Q, in contrast to a decrease of 1.6% in the 1Q.

While the latest estimate of 2Q growth is encouraging, things still don’t look good for the 3Q. The Atlanta Federal Reserve’s GDPNow estimate for the latest week shows 3Q GDP rising only 1.2%, down slightly from the previous week’s estimate. This number will change as the Atlanta Fed gets more input, but it does not look like the better than expected momentum in the 2Q will carry over to the 3Q. I’ll keep you posted.

Stocks Fell Off a Cliff in Late August – Now What?

Unless you’ve been living under a rock, you know that stock markets around the world collapsed in the last couple of weeks. By some measurements, the latest plunge was the most severe in 75 years. On Monday of last week, when the Dow Jones plunged over 1,000 points on the open, the market closed more than four standard deviations below its 50-day moving average. Not even the crash of 1987 got that oversold relative to trend.

From the high in June to the intraday low on August 24, the Dow lost over 15% of its value. While I advised my readers to reduce exposure to long-only equity strategies in April and May, I did not expect such a dramatic collapse. On the other hand, with a market that has been virtually straight up for over six years, you can never rule out something like this.

Dow Industrials

There were multiple worries around the world that sparked the global selloff. There were fears that China’s economy was slowing much more than its government admitted, not to mention that its stock markets lost apprx. one-third of their value in June and July, and the government  devalued the yuan by 4% from August 10-12.

There was also a growing fear that the US Federal Reserve would hike the Fed Funds rate at its September 16-17 policy meeting, a fear that continues today despite the recent rout in the equity markets. In addition, the recent Greek bailout had not been finalized, and there was still concern that Greece could leave the EU. There were other factors, of course, but these were the most cited catalysts for triggering the plunge.

Stocks drifted lower in the days leading up to Friday, August 21 when the Dow closed down over 500 points. It was widely expected that the People’s Bank of China would announce new measures over that weekend to stabilize its stock markets. However, no such news was announced over the weekend, and stocks around the world plunged lower on Monday morning, August 24.

The pre-open consensus on that Monday was for the Dow to open 500-600 points lower. Yet in just a couple of minutes, the Dow was down by 1,086 points on the open! Volume spiked, of course, and the VIX (volatility index) soared to the highest level since late 2011.

While the Dow and the S&P 500 have recovered modestly from the close on Monday, August 24, no one knows if we have seen the bottom yet. I wouldn’t bet on it! I will not be surprised to see these markets at least test the lows seen last week, if not move even lower before we’re done.

Options 101: How to Use Them to Your Advantage

Now that stock market volatility has soared, this may be a good time to consider some of the potential advantages of using options on stock index futures. Also, since I will be introducing you below to our newest recommended money manager – that invests in options on stock indexes – today may be an opportune time to review how options work, and how they can be profitable in the right situations.

Without getting too technical, here’s what you need to know about options as it pertains to this discussion. The buyer of an option contract pays a “premium” for the right to buy (“call” option) or the right to sell (“put” option) the underlying asset at a later date at an agreed-upon price.

Buyers of options often do so as a sort of insurance policy to protect them against large market moves in the wrong direction. Hence, they realize there is a good chance the options they buy will expire worthless (more on this below).

The seller (also called “writer”) of an option contract earns the premium paid by the buyer and is obligated to sell or buy the underlying asset at the agreed-upon price within a specified period of time– if exercised – and that is the key point.

The majority of options on futures are never exercised and die worthless. In that case, the seller (writer) of such options gets to retain the full premium paid by the buyer.

Let’s take a look at the Chicago Mercantile Exchange (CME) where options are traded for the S&P 500 Index and the Nasdaq 100 Index. Many options traded on the exchange were never exercised and expired worthless.

Put differently, the sellers of CME options were often able to keep the premium they received from buyers.

This is very important because the money manager I’m about to introduce you to sells options on stock indexes traded on the CME.

Introducing ZEGA Financial’s High Probability Options Strategy

ZEGA Financial, LLC is an investment manager based in West Palm Beach, Florida. The two founders of ZEGA spent over a decade of their careers as executives at TD Ameritrade, one of the largest national brokerage firms.

Their strategy is called the ZEGA High Probability Options Strategy (“HiPOS”). This strategy is very different from any other program I’ve seen before. Its goal is to generate returns by selling options on major equity indexes, in an attempt to take advantage of volatility in the markets. ZEGA HiPOS is a true “all weather” market strategy or “non-directional” strategy (as we call it), having the potential to make money whether the markets go up or down.

Since the inception of ZEGA HiPOS in November 2010, their Aggressive Growth strategy has delivered annualized returns of over 28%, net of all fees. Their worst drawdown was 20%*. See the ZEGA Fact Sheet for detailed performance information on HiPOS Aggressive Growth Strategy. As always, keep in mind that past performance is not necessarily indicative of future performance.

ZEGA Performance

Why Option Selling (Writing) Can Be So Attractive

So how has ZEGA been able to achieve these performance results? They use a very disciplined approach and only invest when targeted returns exceed calculated risk. ZEGA’s main strategy is to sell options that are nearing expiration, that are likely to expire worthless and hope to keep the net premium collected.

The options positions (S&P 500 or Nasdaq 100) have expirations within 30 days and the strike price must be far enough out-of-the-money – thus the low probability that the options will be exercised. There is a natural “time decay” of near-expiring options, as you can see below:

Time Decay of Options

ZEGA continuously monitors the positions, applying disciplined exit criteria and making adjustments to fit the risk/return expectation of the strategy. The strategy moves to a defensive posture if the one-month loss approaches their exit criteria. ZEGA may also take profits early and exit a position if the markets move favorably early enough in the lifecycle of the trade.

More About ZEGA Financial, LLC

We recently completed our due diligence on ZEGA Financial, LLC including an on-site visit to their offices in West Palm Beach, Florida and met with ZEGA’s founders, Jay Pestrichelli and Wayne Ferbert. As noted above, they both cut their teeth in the executive suite at TD Ameritrade. There they learned to break down the complexity of investing in the stock market into manageable chunks, and gained extensive experience in trading options. They also wrote the book, Buy and Hedge, The Five Iron Rules for Investing Over the Long Term. “

Jay and Wayne went on to found ZEGA Financial and develop the High Probability Options Strategy. This strategy is offered in three different versions with varying risk profiles to meet each client’s individual risk tolerance levels: Aggressive Growth, Moderate Growth and Income. Halbert Wealth will help you determine which of these three programs may be right for you.

As you probably know, there are millions of investors who bailed out of the stock market in 2008 and 2009 – and many have never gotten back in. Since ZEGA is non-directional – meaning it has the potential to perform well in up-or-down markets – HiPOS offers investors who are still on the sidelines an opportunity to get back into the market now. The minimum to open an account is only $50,000.

What’s the Next Step?

Options and options strategies can be complicated, so please contact one of our Investor Representatives to discuss ZEGA’s HiPOS program in more detail and answer any questions you may have. Given that this strategy is non-directional – meaning it has the potential to perform well in up or down markets – now may be a great time to add ZEGA to your portfolio.

Again, you can CLICK HERE to see the actual performance of ZEGA’s Aggressive Growth strategy. If you would like to learn more about this strategy, or see performance information on their Moderate Growth and Income strategies, contact us in any of the following ways:

  • Give us a call at 800-348-3601 and ask to speak to Phil Denney or Spencer Wright
  • Send us an e-mail to info@halbertwealth.com
  • Visit our website Managed Strategies page by clicking here

We will also host a live webinar with ZEGA on Thursday, September 10, at 3:00 pm Eastern. Click here to register.

I hope you’ll seriously consider this non-correlated options strategy as a complement to your existing portfolio.

Wishing you profits in these crazy markets,

Gary D. Halbert

 

Disclosures

*Peak to trough of drawdown: 7/22/11 to 10/3/11.

IMPORTANT NOTES:  Halbert Wealth Management, Inc. (HWM) and Zega Financial, LLC (ZFL) are registered with the SEC and/or their respective states. Information in this report is from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. HWM pays a fee to ZFL in exchange for managing client accounts. For more information on HWM or ZFL please consult the respective Form ADV Part 2, available at no charge upon request. Officers, employees, and affiliates of HWM may have investments managed by the Advisor discussed herein or others.

As benchmarks for comparison, the Standard & Poor's 500 Stock Index (which includes dividends) and the Morningstar US ETFs-Trading Leveraged Equity Index were used. They represent unmanaged, passive buy-and-hold approaches. The volatility and investment characteristics of these Indexes may differ materially (more or less) from that of this trading program since they are unmanaged Indexes which cannot be invested in directly. The performance of the S & P 500 Stock Index and the Morningstar US ETFs-Trading Leveraged Equity Index is not meant to imply that investors should consider an investment in this trading program, which is an actively managed options program, as comparable to an investment in the “blue chip” stocks that comprise the S & P 500 Stock Index, or the largest leveraged US equity ETFs that are used to calculate the performance of the Morningstar US ETFs-Trading Leveraged Equity Index.   

Performance reflects the actual aggregated performance of the ZEGA HiPOS Aggressive Growth Strategy in Zega’s client and employee accounts. These numbers reflect the deduction of a 2.25% fee, which includes the fee paid to ZFL. These performance numbers have not been verified by HWM, and therefore HWM is not responsible for their accuracy. Since all accounts in the program are managed similarly, the results shown are representative of the majority of participants in the ZEGA HiPOS Aggressive Growth Strategy. Statistics for “Worst Drawdown” are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results. The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; v) accounts may hold different securities depending on when the client invested and any restrictions placed on the account; and vi) the rate of brokerage commissions, transaction fees and management fees charged to an account may vary. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the ZEGA HiPOS Aggressive Growth Strategy.

 In addition, you should be aware that (i) in the ZEGA HiPOS Aggressive Growth Strategy, your principal is not guaranteed and there are risks involved; (ii) the ZEGA HiPOS Aggressive Growth   Strategy’s performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) ZFL will have trading authority over an investor’s account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the ZEGA HiPOS Aggressive Growth Strategy’s fees and expenses (if any) will reduce an investor’s trading profits, or increase any trading losses.

This strategy uses options which involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics of Risks of Standardized Options. This may be obtained from HWM, from any exchange on which options are traded, or by contacting The Options Clearing Corporation at 1-888-678-4667. ZFL will engage in “naked” option trading, which is the most speculative form of trading.

Management fees are deducted quarterly, in arrears, and are not accrued on a month-by-month basis. Returns do not include the effect of annual IRA fees, if applicable. No adjustment has been made for income tax liability. Consult your tax advisor. “Annualized” returns take into account compounding of earnings over the course of an investment’s actual track record. Money market funds and other low risk asset classes are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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