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Don't Sell -- Hedge In May and Go Away

NEW YORK ( TheStreet) -- Every May the mantra "Sell in May and go away" is repeated endlessly as to suggest only fools hold stocks into June. If true, does Wall Street pack up for the summer, turn on voice mail and head to the Hamptons (for more than the weekend)? Should investors heed Wall Street's admonition and exit while they can? Fortunately, there are methods to protect your portfolio without selling.

SPDR S&P 500 ETF SPY (SPY), Apple (AAPL) and SiriusXM (SIRI - Get Report) are widely followed equities. They make perfect examples, albeit for different reasons.
Apple last year was a terrific example of selling in May -- but only if bought again in June.

The 2007 and 2008 SPY charts make a convincing argument that indeed only fools hold stocks beyond May. Ignoring dividends earned, Investors buying SPY at the close of May 2007 have been underwater since January 2008. Unfortunately, dividends are not enough to push buyers over the top and realize a gain. On the other hand, even though diving off a cliff following May 2008, SPY has already recovered. We all want to believe we will correctly time the next market drop, but most are unable to consistently.

Apple last year was a terrific example of selling in May -- but only if bought again in June. Apple's price did close June down from May. Unfortunately, absent a subsequent repurchase, sitting out of Apple results in watching a 60% price rise without you. Again, most astute investors will leave precision timing to active traders.

Sirius last year provided our best example for selling in May. Sirius' price at the end of May 2011 was $2.35, just off a recent 52-week high made in the same month. No monthly closing price has been higher, and the May high remains the highest price paid since. Travel back one or two years (but not three) and once again an impressive run is missed; further proof how difficult timing entries and exits may be. (Oliver Pursche wrote an intriguing sell in May article explaining why this may be the wrong year to "go away in May.")

Timing a stock or the market is no easy task. Tempting as liquidating stocks into cash is in today's market environment, another solution uses option hedges. Investors can sell covered calls against their shares to protect against a fall in prices, while not totally missing out if their stocks move higher.

Instead of selling SPY today for, at the time of writing, $131.53, an investor can sell the August $125 strike call for $9.50. If SPY moves lower during the summer doldrums, the call option will protect the position for the first $9.50 lower. If SPY moves higher, another $3.47 is added for a 2.6% improvement in return yield. If SPY trades flat through the entire summer, a covered call is still advantageous compared with selling.

Arguably a single stock such as Apple is riskier than owning the SPY ETF, but without risk there is no reward. I like Apple long term and consider the recent retracement as a buying opportunity (again with options to mitigate risk). If you are searching for an alternative to "selling in May," selling the September $535 calls is compelling. If Apple moves lower, a covered call hedges the first $55.50 drop in price. Apple must close below $499 on option expiration day in September before selling now is an improvement. If Apple trades higher or even remains flat, a covered call increases return more than 6% versus selling in May.

Like Apple, Sirius poses a greater risk and potential reward compared with the SPY ETF. The September $1.50 call option sold for 48 cents hedges an investment for more than 25%. At the same time, an additional gain of 3% is retained if Sirius moves higher.

Buying previously sold covered calls avoids losing shares to option buyers. After fear of a market downturn in June, July and August, has passed, hopefully without incident, buy calls sold (hopefully at a better price as a result of time decay) and look forward to the upcoming holiday season again.
Author does not hold a position in any stock mentioned.

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