200-Day Moving Averages Breached

All four major North American markets have just dropped below the 200-day moving average today. Toronto, the Dow Jones, NASDAQ, and the S&P 500 are down between 1.7 and 3.5 per cent on more terrible news in Europe.

A drop below the 200-day moving average is not a good sign. Long-term investors should consider protecting their assets through a variety of hedging strategies, preferably writing deep in-the-money calls. Consider selling June strike prices 5 per cent below your stock's current value, or even higher if you think there is a 20 per cent correction on the horizon. Just be cautious as this is an automatic exercise if the market turns around sharply or decides to stop falling.

For example, Bank of Montreal [BMO:TSE] is trading at $59.90 (at 12:50 PM EST) and the June 58 call, which is $1.90 in-the-money or 4 per cent, is bidding $3.30. Time value is $1.40. So, if your stock falls below $58 by June 18, you earn $3.30 to offset any loss on your stock. It also allows you to be a little wrong. If BMO finishes at the same value that it is today, you still make $1.40 and if it goes up, you earn the difference of $1.40 and how much the stock is up.

This strategy replicates a sell today without creating a down tick on the market itself and allows you to capture any time value on the option. As well, most widely held stocks are going ex-dividend by June expiration and I sense many investors are not in the mood to trade.

The other levels we should keep an eye on is the Dow Jones at 10,000. Although this level is not a real technical level, it is a psychological level that many amateur traders might use to sell or try and push the market lower.