Saturday, May 2, 2009

Can we outperform S&P 500?

This must be every mutual fund manager's goal to outperform S&P 500. However, only a few can actually achieve it. Even Mr. Buffett's four candidates to succeed him as Berkshire’s chief investment officer failed to outperform the Standard & Poor’s 500-stock index in the year 2008. 

It is pretty naive to dream stock goes up forever eventually. Even it could be true, anyone can only live limit amount of time. The time frame when you need money the most could be the time the market is way down. Retirees these years all have painful experience.  Many people rush to CD, treasury and bond for safe heaven. But, I think we can do much better than that. 

1. Open an account with option enabled, at least: covered call, long call/put and cash secured put.
2.  When market runs up a lot and almost everyone expects it could go down, see S&P at 950 points, sell everything and keep it in cash. 
3. When market come down, see S&P below 750 points, it is time to buy. But, you might be too scared to death to buy anything at that time, which is normal.
4. Instead of buying anything, you can go ahead sell SPY DEC 2010 70 puts if you believe S&P can go above 700 points by DEC 2010. If you want to take more risk, yo can sell SPY DEC 2010 90 puts (Consider S&P was as high as 1500 points, 900 points in two years is reasonable). 
5. Now, you receive cash premium immediately and you can use it to do whatever you want. Use it to buy CD, or withdraw it to pay your bill, etc.
6.  The original principal in your account becomes the collateral for your underwriting put and it is put into money market account (Fidelity calls it cash reserve fund) to generate interest. But, you cannot touch it until DEC 2010, which is good thing because it prevents you doing anything stupid.

Mr. Buffett did exactly the  same thing and he did it when S&P was still at 1300 points. Even we do it now, which I actually think we should do it when S&P below 750, we still have lots of safty coushion. You might think this approach might be too conservative and it could miss the opportunity. Well, 300 points for a year is a lot for S&P if it is not the best in history.