2 Reasons Why Keeping Cash Is A Great Idea In Volatile Markets

volatile markets

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The past three weeks have been some of the most volatile trading in the last three years; all the more reason keeping a good stack of cash is a great idea in a volatile market. Most options traders incorrectly think that they need to have money invested at all times in the market. They force trades into the market when the risk/reward ratio  isn't there.

What can we learn from this "mini-crash" we have all just gone through? Well, if you are an options traders you learned two valuable lessons on why keeping cash is so important in a rising volatility market.

1) Cash leaves room for margin expansion...

I think there is no question that a lot of new options traders learned that their margin account can  increase very rapidly on them. And if they were 70-90% invested before the selling started then the term Margin Call become a new vocabulary word.

Having cash ready and low levels of margin usage in a low volatility market leave room for that margin to expand with increasing volatility. If you didn't over-invest then you have plenty of room in your portfolio to withstand the market swings and come out alive (or at least not with a blown-up portfolio).

2) Cash on hand can be used for ridiculously profitable trading opportunities...

As the VIX above shows, high volatility levels can be easy pickings for options traders. Since they historically don't last long, those traders who have additional cash on hand can go out and "bottom pick" the market for ridiculously easy profits.

One way I that I like to take advantage of this is with short naked puts. Just this past Friday, you could sell a Put on the S&P 500 at a strike price of 750 and take in a premium of nearly $167 per contract! That's an easy 2.23% return in 24 days, AND the market would have to drop another 35% for you to lose money.

Again these are the kinds of easy trades that you can make if you keep some cash in your portfolio.

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Technical Indicators Show We Are Near A Bottom

All the indicators out there are showing that we could be setting up for a very strong and sustained move off these August lows in the coming month. Everything from insider buying to sentiment indicators shows buy signals.

Probably on of the biggest signals comes from the NYSE Percentage of Stocks above their 200-Day Moving Average. As of Friday, this indicator is at the same level as previous major stock market bottoms.

I know it came be hard to get back into the market after the huge swings but if you want to be an emotion-free trader who uses technical analysis, now could be a good time to start build up your portfolio again.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.