How to Make Money in a Sell-Off

Karim Rahemtulla By Karim Rahemtulla
Options Strategist

Alternative Income

Technology shares have taken a beating of late. Some of the highfliers of 2017 and early 2018 are down 20% to 50% in a very short time period. That kind of loss hurts big time. Even the favorites haven’t been spared.

Facebook (Nasdaq: FB), Tesla (Nasdaq: TSLA), Netflix (Nasdaq: NFLX), Amazon (Nasdaq: AMZN) and a host of other well-known names have entered – or are close to – bear market territory. To be sure, these companies are powerful. Facebook, for example, has excellent fundamentals, trading at multiples to earnings that are half its growth rate.

So what gives?

Investors love momentum… until they don’t. And when sentiment shifts, the companies with the most distance from the mean will often suffer the most.

There is a term that investors use. It’s called “reversion to the mean.” That implies that sooner or later, stocks (like just about everything else in life) return to historical norms.

If you’re on the right side of the momentum trade, you could make a fortune before the reversion occurs. But if you’re buying something without understanding what you’re investing in, then you are likely going to suffer a 2008-style meltdown in your portfolio.

This happened during the dot-com collapse. Not all stocks crashed. The ones paying healthy dividends, earning real money and trading within historical norms fared well (comparatively) while many companies in the dot-com sector lost almost 90% of their value or went out of business.

If you are an investor looking for bargains, then these types of sell-offs can be the best thing that ever happened to you. Look for great fundamentals like growing earnings, low debt, strong dividends and dominant market positions. These are the fundamentals that matter in the long run.

The current downdraft is severe but not anything that you should lose sleep over. In January, I began positioning myself in cash. Before you accuse me of not sharing my opinion, here’s how I ended an article in early January

“And I am certainly trimming my exposure to the market or using strategies that hedge my bets or allow me to buy select companies at much lower prices than where they are trading today.”

So here we are. The major indexes have all experienced a correction of around 10%. So now I am putting my cash to work. That said, I am not going all in. That would be foolish.

What I am doing is looking for bargains. To me, that means two things…

First, I am selling put options on fundamentally sound companies. When you sell put options, you are obligating yourself to buy stocks at a lower price if the stocks hit that price at expiration. But thanks to volatility, I am getting paid thousands of dollars to enter these trades.

Imagine that: The market is PAYING me to buy great companies at huge discounts… after they have already had a massive price cut!

Second, I am buying dominant companies that have been sucked down by this correction. This means companies that are paying healthy dividends that they can afford – the types of companies that my colleague Marc Lichtenfeld specializes in. If they can handily afford their dividends, occupy top positions in their sectors, and grow their earnings while trading at a discount to the market and their historical trading ranges, count me in.

I suggest you do the same. Look over that dream list of companies that you wished you owned. Look over their fundamentals and start buying in.

Over the long term, the market will move higher and so will high-quality companies. The key is to buy them when you can get in at bargain prices.

Good investing,

Karim