A ‘Half and Half’ Options Strategy To Protect Against Falling Stocks

Articles From: Barron's
Website: Barron's

The Tower of Babel has nothing on Wall Street.

On any given day, the Street’s pundits and marketing machinery extol and decry so many potential risks and rewards that it is often impossible to make sense of the passing scene.

On Monday, stocks rallied higher and investor sentiment was broadly positive. But Tuesday’s release of the consumer price index wasn’t the Happy CPI Day touted by some pundits.

The economic report was worse than expected, and stocks plunged because the Federal Reserve now lacks any pretense for reducing the pace of interest-rate hikes. Investors are bracing for ones that are more aggressive than previously expected.

This shouldn’t surprise anyone who lives in the real world. Inflation—as everyone who buys groceries knows—is still a major problem. For people who live in the finance bubble, take heed of Goldman Sachs. The bank is expected to start reducing staff to reflect the current environment.

So far this year, we have detailed a few different approaches for navigating this transitional time in the market.

We advocated selling call options on Ì stocks to enhance yields. We suggested watching the Cboe Volatility Index  and selling put options on blue-chip stocks when the VIX hits 30 to take advantage of extreme fear.

We urged investors to “buy the dips and sell the rips” to take advantage of any short-term rallies that might occur as the Fed normalizes monetary policy. We advocated hedging portfolios when it wasn’t expensive and stocks were higher.

Rather than clamoring aboard the noise machine that is often wrong but never in doubt, options investors can monetize short-term volatility in a variety of ways to express long-term investment themes. 

The “half and half” strategy offers a different way to manage risk and potential returns. Investors who want to buy stocks but are worried about the price declining can buy half as much stock as desired, while selling puts on the other half to potentially buy more at lower prices.

Consider Hormel Foods (ticker: HRL). The maker of Spam has a reputation for doing well when times are challenging. When people try to save money, that often benefits less costly foods.

With Hormel at $46.17, investors could buy 500 shares and sell five January $40 puts for about $1. The strategy obligates one to buy stock at an effective price of $39, which would lower the entire position’s cost basis to an average of $42.50. During the past 52 weeks, Hormel’s stock has ranged from $40.48 to $55.11.

Michael Schwartz, Oppenheimer’s chief options strategist, says that investors are better off trying to use time to their advantage than trying to time the market. “Many investors are confused about what comes next, so using strategies that help monetize uncertainty is a way for long-term investors to potentially profit,” he says.

These strategies are ways for investors to engage in what we have long called “time arbitrage.” Investors who are comfortable with options can use puts and calls to take advantage of short-term volatility in anticipation that tomorrow may be less dramatic than today’s challenges.

Anyone who considers this approach is likely to have better outcomes than those who try to game single economic reports or simplistic views of technical analysis.

Play the long game. Trade the market that you have, not the one that you think exists. Be a realist. Manage your risk. Ignore noise and focus on well-run companies, especially when current financial conditions are bullying their stock prices.

Originally Posted September 14, 2022 – A ‘Half and Half’ Options Strategy to Protect Against Falling Stocks

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.

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Disclosure: Options Trading

Options involve risk and are not suitable for all investors. Multiple leg strategies, including spreads, will incur multiple commission charges. For more information read the “Characteristics and Risks of Standardized Options” also known as the options disclosure document (ODD) or visit ibkr.com/occ