Seesaw markets,my plans, a good book and market crisis

The month of jan was a complete rollcoaster. Initially the market shotup, then crashed and now seems to go one step forward and one step backward.

One could have made a killing shorting the market or by buying puts. I however did none of that. I personally need to do more homework in that area to venture into it. However I do see puts as a decent option to hedge the portfolio. The part I still need to work out is this -

Most options expire worthless. The reason is that the options market is fairly efficient, definitely more than straight equity. So is it possible to buy puts over the long term, make money a few times only and still have a decent return after all the costs ?

Some of my own holdings, some of which I have discussed (and some not), have declined below 50% of intrinsic value. Earlier I would get mixed feeling – pained by the decline and excited by the opportunity to buy more. Now I get more excited than pained. I however try to re-analyse the position and check if I have missed something which the market is discounting. In the past my key mistake was not putting more money into such ideas – Blue star, concor, Pidilite etc.

I just finished reading the book – A demon of our own design. I am not going ga ga over it. However it is a good book. This book came out 6-8 months back and is fairly presceint of the current subprime crisis. The book discusses the past crises like the 1987 US market crash and the LTCM collapse. One key point the author makes is that the main cause of the market crises is tight coupling and complexity.

Complexity in the markets is mainly due to the complex instruments such as CDO, derivatives etc which very few understand. In addition these instruments are non linear and it is diffcult to model them. That’s why a lot of the companies holding these instruments are not able to compute their value and appear clueless. By tight coupling the author means is refering to the linkages between companies and markets. That is easy to see even in India. 10 years back a subprime crisis would not have affected the Indian markets. However inspite of no direct exposure, indirect linkages via hedge funds and FII are causing these wild swings in the market. All in all a decent book.

I am a big fan of warren buffett and have read his annual reports several times. He purchased a company called GenRe in 1999 and wound down their derivative operations over 3-4 years. This was done during normal times and by one of the smartest investors around. Inspite of that the company took 400Mn or higher writedowns. Buffett noted in his letter then (2002 I think) that inspite of such orderly and planned unwinding, they faced such losses for such a small derivative operation. The larger banks (read citi, JP morgan and others) may face much higher losses if they have to unwind their derivatives during a market crisis (now).

So personally I think market problems are far from over and we may get more buying opportunities in the future. Will the market crash or will it be a bear market?? ..i don’t know. Either way I think it would be good to keep some cash around to take advantage of opportunities as they come up.