A Defensive Strategy That Works

A big theme in my writing -- at TheStreet.com and on my blog -- has been taking defensive action amid unhealthy demand for equities. There are several ways to measure this. I prefer taking defensive action when the S&P 500 goes below its 200-day moving average, then getting fully invested when it goes back above that point.

As Ken Fisher has said many times, the market can only do four things: go up a lot, go up a little, go down a little or go down a lot. My use of the 200-day moving average is to try to miss as much as possible of that last one.

The attached chart shows a way that might help mitigate the full brunt of a bear market. It compares the S&P 500 (with its 200-day moving average in blue) and the CBOE BuyWrite Index(BXM Quote).

Taking Defensive Action

Click here for larger image.

Source: BigCharts.com

The BXM strategy is to buy the S&P 500 and sell at the money front-month calls. The intended effect is less volatility with the hope that it would outperform the regular S&P 500 over long periods of time. Every back test I have ever seen bears this out, but BXM should be expected to lag in years the market is up a lot, like 2003.

One way for broad-based ETF investors to take defensive action, without completely getting out of the market -- more on that below -- would be to hold the iShares S&P 500 Index Fund(IVV Quote) when the S&P 500 is above its 200-day moving average and switch to the PowerShares S&P 500 BuyWrite ETF(PBP Quote), which is benchmarked to BXM, when the S&P 500 is below that average.