There is a pervasive sense that one must be either be bullish or bearish.  But, a legitimate third choice is cash.

I’m not suggesting shoving money under your mattress. But, with the recent market decline, and increased volatility, moving to the sidelines might make the most sense.

There has been debate as to whether cash could even be considered an asset class, which strikes me as ridiculous — given its very definition, an asset relies on the notion that it can be converted into some form of currency, aka cash.

I think the misrepresentation stems from when we let the brokers, stock, real estate, insurance etc, confuse the idea of investing or ability to trade, with an asset.

After all, what provides a better mark-to-market and more liquidity than cash?

By contrast, I remember when the VIX futures and ETFs were first launched and the sponsors, from the CBOE exchange to the product creators, pitched volatility as an asset class.  As if one could live, grow or even convert this mathematical financial product into a house, food or peace of mind.

As the stock market undergoes what might be a transition into a bear market having a higher cash position allows you to manage risk by avoiding a portion of the downside price action. Getting out of your current positions (if they’re in liquid, public markets) doesn’t cost you much more than the commission to execute the trade and provides an immediate source of portfolio protection when the stock market is falling.

The second reason is that raising cash allows you to be more flexible with your portfolio. Whether you’re switching from neutral to bullish or bearish, you’re going to need capital to put to work when conditions shift in direction or another.

While money managers, from pension to hedge funds, are required ‘to be invested’ and be active, for individual investors keeping some dry powder is a crucial component for both capital preservation and exploiting opportunity.

Cash is the ultimate asset.  Keeping some at hand makes perfect sense.

About the Author: Steve Smith

Steve has more than 30 years of investment experience with an expertise in options trading. He’s written for, Minyanville and currently for Option Sensei. Learn more about Steve’s background, along with links to his most recent articles. More...