This week and next, the TheStreet and RealMoney will be exploring the aftermath of Lehman Brothers' bankruptcy filing and the ensuing market chaos it brought to a head almost a year ago. This newsletter was sent Tuesday to subscribers of Najarian's "Deep in the Money Calls" service. For a free trial of his newsletter outlining all his options strategies, click here.
NEW YORK (
) -- We'd like to share with readers some of our thoughts about the events that took place about a year ago, when the collapse of
sent the financial system careening toward the precipice.
Living through the 12 months since Sept. 15, 2008, has been like living through a war: Things we never thought could happen did, in fact, happen. Such figures as economist Nouriel Roubini and banking analyst Meredith Whitney emerged as new financial news heroes, while older authorities we had trusted for many years, such as the credit-rating agencies, were badly embarrassed.
Nothing Is Too Big to Fail
The biggest message the crisis imparted was that no company is too big to fail. Quite frankly, investors had become far too complacent in their trust of institutions like Lehman and the larger financial institutions. Investors should always be skeptical when something seems like a certain bet, because it often means that everyone else is positioned in the same way. That means you're probably in a crowded trade and could get trampled if everyone rushes for the exits at once.
This is especially true for financial institutions, which relied on huge amounts of borrowed money to operate. I sometimes think that big banks are like airplanes: If you're in a little propeller plane traveling at 200 miles an hour, you can open the window or withstand a small aerodynamic flaw in the wings or fuselage. But if you try the same thing with a jet that is a traveling at 600 miles an hour or more, the entire aircraft could rip apart. In this case, leverage is like airspeed. Everyone likes to go fast and to make as much money as quickly as possible. But that type of strategy also creates new risks and narrows the margin of error, as one small mistake could spell disaster.
One encouraging thing we have learned from the meltdown is that if the crisis is bad enough, authorities such as the
and Treasury Department will step in and the keep the system alive. While that won't keep anyone from losing money, it shows that we still have a modern financial system that can be rescued by public officials. The U.S. isn't a developing country or ailing corporation. There is a deeper pool of institutional strength, and officials have plenty of tools at their disposal to keep our systems running.
So, if you know the overall system will survive but that no company is too big to fail, the next lesson is that buying protection is never a bad idea. While our Alerts for this service focus on a long-only strategy, put-buying is an integral part of our personal investing style. Most people who drive cars don't think twice before getting insurance. Why should your own portfolio be any different?
Protection-buying makes more sense now than ever before, given the steady decline in the CBOE Market Volatility Index (VIX) since March. It's now in the mid-20s and has been unable to move through the 24 level. Anything can happen as everyone gets back to business after Labor Day, so it can be a good idea to buy protection now in order to guard against a possible decline in the broader market. We're still bullish over the longer term and believe the economy has found a floor, but we could face a correction or a spike in volatility over the next month or so.
A simple way to obtain this protection is to purchase puts on an instrument such as the
, an exchange-traded fund that tracks the
. Depending on how your portfolio is allocated, you can also buy puts on the
iShares Russell 2000
, which track the small-cap universe and the Nasdaq 100, respectively. For instance, the PowerShares QQQ closed at $40.36 on Friday. We'd typically look to buy puts about three months into the future at 1-2 points below the price of the stock. In this case, we'd be interested in the December $38 puts or something similar.
Don't Ignore the Charts
Finally, a huge lesson we've learned over the past 12 months is not to ignore the charts. Technical analysis has emerged as a major tool helping investors to steer their way through the markets. Before the crisis, we seldom looked at price charts when putting on a trade.
We now routinely examine the recent price action and look at how a stock is interacting with key moving averages such as the 50-day, 100-day and 200-day. In fact, that was a part of the rationale behind some of our latest "Deep in the Money" picks, including
Johnson & Johnson
. It's unlikely that we'll ever trade purely off the charts, and we still plan to do plenty of fundamental homework before making any new picks. But we've definitely developed a new respect for technical analysis as a trading tool.
Written by Pete Najarian in New York