There is a Chinese proverb – ‘May you live in interesting times’ which may be a curse in disguise. The essence of the proverb is that if you want to condemn a person, you would wish that the person encounters ‘interesting’ times or in other words a lot of change and turbulence.

I don’t think anyone has cursed us, but we are definitely living in interesting times. I think the really interesting times started from 2008 and there has been no letup in the excitement.

The Greek tragedy
If you have been following the news, we have quite a situation in Greece. If one leaves aside the nitty gritty of the situation, it can be simply described as living beyond the means. Greece as a country has been spending (the government that is) way beyond its means (tax revenue) and covering up the deficit by borrowing from the market.

They were able to do it for sometime, till things finally came to a head a few days back. The market decided, enough was enough and started hammering the euro and European bonds of countries such as Greece, Spain, Portugal etc. It became quite scary by Thursday when the US and other markets started dropping by 3% or higher and volatility spiked by more than 50%.

The EU and ECB (European central bank) came together over the weekend and have put together a financial package of 600 billion dollars to aid the countries in trouble. This package has calmed the markets for the time being and would give time to countries like Greece, Spain etc to set their house in order. It remains to be seen if they will bite the bullet and fix their deficits. If they do not, then the markets will force them to in due course time.

My reaction
I typically ignore market fluctuations and macroeconomic situations. In this case however, there was a real risk of a market meltdown in Europe and US and a corresponding crash in India.

As I have already stated, I have started liquidating stocks which I would not buy if they dropped by 20% or more. I have already exited my positions in stocks such as VST, Denso, Ingersoll rand and started reducing my positions in IT stocks such as Infosys, Patni and NIIT tech (see my portfolio disclosure here)

My decision to sell is not a macro call. I have no clue how the macro picture will play out in Europe and how it will impact us in India. There are a lot of moving parts to be able to predict and all the opinions in the papers and on the TV are just that – opinions and guesses.

My decision to sell is based purely on valuations and my view of the future prospects of these companies. I am not too optimistic about IT companies at current valuations (key word is current valuations – the companies may still do well in terms of performance).

Exploring options
I am exploring the idea of ‘Deep out of the money’ puts to take advantage of a possible crash in the market due to the European debt issues. There are multiple issues associated with this thought process.

The first issue would be the possible corruption of my value investing philosophy. The general wisdom is that value investors should not dabble in options. Options are more suited for a trading or quantitative approach to investing. I would disagree with that. Value investing is not some religion, where you are either a part of the cult or out of it. Value investing at its core is buying something for less than its value. The ‘something’ can be a stock, option, bond or even a TV. So if I can find an undervalued option, and can evaluate the risk intelligently then it is as much a value buy as a stock.

Options are priced based on a Gaussian distribution (difficult to explain in detail in this post) and hence underprice extreme events. So if a company in question is likely to show great performance in the next one year or crash completely, the options may be underpriced for such a scenario. Similarly, put options may be underpriced if the market crashes due to some extreme event. The risk is ofcourse that the extreme event may not happen and you will be out of the premium you paid for the option.

I have been studying derivatives for sometime and have been analyzing them. Although I still look at them as a hedge or insurance against extreme events, I have been exploring the idea of combining value investing with options.

The main risk I personally face with options is not monetary risk as my positions are very small. If I lose money, it is likely to be a small amount. The bigger risk is that I will look like a complete fool in my own eyes (that I will look like a fool to others is a lesser issue). In order to avoid the regret and learn from my experience, I have started maintaining a daily dairy of my options work and have started recording my thoughts, feelings, actions etc.

As an aside, I bought puts on ICICI bank and some other companies in late 2008 to hedge my portfolio and deposits with these institutions in the extreme event that one of them failed and took my savings down with them.

If you think a value investor should never touch options and I am being foolish to do it, please leave me a comment with your reasoning behind it.

I was. If you are invested in midcaps or small caps, then it is likely that you would have seen some of your picks jump 5-10% in a day. I have seen some of my picks jump by that amount and some of the companies I was analyzing have gone up by the same amount and thus rise beyond my buy levels.

Feeling happy?
So how did you react to all this? happy?
I can bet that you must feeling good about it, unless you love self torture,. I was feeling good too, till I realized that the mid-cap and small cap index has risen by 100%+ in the last one year with several stocks going up by 200-300% percent in the same time.

When I saw this statistic, it poured cold water on my euphoria and reminded me of the following quote
‘A rising tide lifts all boats’

So there is nothing special in my boat or in other words, in my stock picks. I was lucky to be in the right place at the right time.

What does this mean?
If you are thinking – what makes this dude happy? A 100% rise in the midcaps and small caps and all he can do is whine about it!

Don’t get me wrong. I am happy that my picks and possibly yours have rise so rapidly in such a short time. If you had the courage to buy stocks a year back, then you have been justly rewarded.

The under pricing however got corrected some time back and now we may be entering a bit of a happy zone where everyone thinks that the future is going to be all bright and sunny and there will never be any problems.

The reality is that the future is never crystal clear. This risk we now face is that any negative news can cause the sentiment to sour and the midcaps or small caps to drop.

What to do?
As I said in my last post, I have started selling those stocks which I will not buy if they were to drop 20% from current levels. If I am not too optimistic of the fundamentals or think the stock is at fair value, I have started selling my holdings. I may be completely wrong about it and we may get another 50% rise.

So be it.

I think in my case greed is more difficult to manage than fear. I did not second guess myself to load up on stocks last year when the market tanked. The decision to start selling now is more difficult.

What am I selling?
I have started liquidating my smaller position like Denso, VST etc. I will however hold my long term holdings such asian paints, CRISIL etc. If the market tanks, I will load on them further.

Should you do what I do?
Think of it this way –
What incentive does Rohit have in mis-leading me? (Hint – none!). So you can listen to me.

What if I am wrong? Do I lose anything? No, I don’t. This is a personal blog, so I can write whatever I like. Hopefully I am not adding to the crap out there on stock markets 🙂

So please do your homework and think twice before taking free advice 🙂 (does not mean paid advice is any better)

I wrote a similar post on miscellaneous topics in Feb. I am able to use these posts to ramble on several disconnected topics which in themselves may not warrant a post.

Facor alloys
I recently analyzed this stock here. As luck would have it, Arcelor mittal – the LN mittal company seems to be in talks with the management to acquire a stake in a sister company – Ferro alloys corp (I received a comment on the same recently)

The management of the company controls three companies – Ferro alloys corp, Facor alloys and Facor steel. Ferro alloys corp owns and controls the Chrome mines. Facor alloys, also controlled by the same management has been able to access these mines and is in the business of manufacturing chrome alloys.

Chrome alloys are used in the manufacture of Steel and thus these talks on stake acquisition make sense as they would represent backward integration by acerlor mittal. These talks may or may not be successful, but the market has already responded by increasing the price by 10% for Facor alloys.

The stake accquistion seems plausible and could be a good trigger to exit the position. However I would not base my decision on this criteria alone. One should be convinced that the stock is undervalued and these kinds of events would only unlock the value

Sulzer india
I wrote about sulzer here. I have since then exited the position completely. I was able to get a 45% gain in 6 months. I am definitely pleased with the outcome. However this was sheer luck and nothing more. If I assume that I have the skill to make 90% returns per annum, then I can plan my retirement in the next 2-3 years.

Psychology of investing
I received two comments, which touched upon the issue of how can one manage emotions in the market ? If one has invested a sizable amount of savings in the market how does one handle the market swings ?

I personally think that the intellectual part of investing – learning the basics and the fundamentals of stock analysis etc is not too difficult. Any smart person should be able to cover a decent ground in 2-3 years. The most difficult part is handling the emotional roller coaster of the stock market. That takes a lifetime and sometimes even a lifetime is not enough.

I think some people assume that one is born with the temperament to handle these emotional swings . I do not agree with that. There is definitely some level of temperament involved, however one can train oneself to become better at it.

During my early days of investing, I would get happy and greedy when the market went up and anxious when my stocks dropped. I went through considerable self –doubt too. I was always asking myself – do I really know what I am doing?

However if one focuses on learnings from mistakes, then over time the self doubt reduces. I still feel good when my stocks do well or unhappy when they drop, but I do not base my decisions on how I feel. The only antidote to these emotional swings is to learn continuously and know what you are doing.

At the same time, if you feel anxious and are losing sleep when the market drops by a few percentage point, then it is a clear indication that you have taken on way more risk than you can bear. The reasonable course of action in such a situation is to reduce the amount of money in equities and increase the allocation in debt.

Ask yourself a question now – are you feeling bullish these days? if yes, then you are thinking like all others. The time to be bullish was Jan-Mar 2009. I am not bullish or pessimistic these days, but I am definitely cautious.

Responding to emails
I have been slow in responding to personal emails. If you have written to me and have not heard from me, my apologies. I read all the emails I receive, though my responses are delayed sometimes.
If however you have written to me asking for my opinion on a stock, I would prefer if you did some homework at your end and shared your analysis with me. I would then be able to provide a better response to you.

Overall portfolio plan
I am now adopting a slightly different approach in making sell v/s hold decision. I am now asking this question – If this stock drops by 20-30%, will I add to it or do nothing. If the answer is ‘do nothing, then the stock is a good candidate to sell.

I have exited my position in VST and would be doing so in case of some other stocks as the gap between the price and fair value reduces further. The issue is not if the stock is good or not, but whether there are better ideas in the market. Holding an average idea may not result in a direct loss, but there is always an opportunity loss if the stock does not rise as much.