This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.

Investors Are Frightened. How to Use Their Fears to Profit.

Barron's

Contributor:
Barron's
Visit: Barron's

Fear is back in fashion.

It’s hard to be definitive about anything in such an erratic environment, but the latest Covid variant, coupled with the realization that the Federal Reserve’s easy-money policies may end sooner than expected, has roughed up stocks and elevated fear premiums in the options market.

The market’s fear gauge—the Cboe Volatility Index, or VIX—had seemed stuck at a somnolent level, as if to suggest investors had forgotten stock prices sometimes decline. It has surged in recent weeks.

The VIX was around 15 in late October and recently peaked around 32. Some strategists contend that a level of 30 in the VIX signals fears of an economic recession.

In testimony Tuesday before the Senate Banking Committee, Fed Chairman Jerome Powell said it was time for the bank to stop characterizing inflation as a transitory phenomenon. The stock market sank in response and the VIX surged, though it has since reversed some of the move.

Much will be made of the VIX’s peregrinations, but this much we know: Investors who have long shunned put options are now buying them to hedge their portfolios. The trend began in August, even as stock prices kept marching higher. Yet it took the emergence of the Omicron variant—and Powell’s seeming recognition that inflation might not fade so quickly—to firmly change investor sentiment.

The sudden demand for puts, which increase in value as stock prices decline, has helped to recast an odd market dynamic that has characterized much of the year.

As stock prices advanced ever higher, call option premiums tended to rise, too. The rush to buy calls, which increase in value as stock prices rise, has made bullish calls often more expensive than bearish puts.

The opposite is usually the case.

The shift back to normal market dynamics is, at least for now, an opportunity for anyone who uses options to navigate the stock market. For investors who want to buy stocks on weakness, elevated put premiums might look attractive. By selling a cash-secured put, investors can get paid by the options market for agreeing to buy a stock at a lower price.

The put-sale approach works best for investors who have high convictions about a stock and a horizon long enough to overcome short-term volatility.

We have consistently advised investors to consider selling puts on blue-chip stocks that pay a dividend and that can be held for three to five years. Now, however, it makes sense to be more nuanced. It is hard to have any clarity around the Omicron variant or even the Fed’s actions.

Aggressive investors looking for an opportunity to trade should consider sticking with options that expire before the Fed concludes its next meeting on Dec. 15. It’s hard to know how the market will react to more hawkish commentary about rates and tapering, or even the absence of such comments.

For those who can’t wait, and for those who always like to trade, consider selling puts that expire Dec. 10. One possible vehicle: the Technology Select Sector SPDR exchange-traded fund (ticker: XLK), which comprises many major technology companies that could be viewed as safe havens in uncertain times.

With the ETF at $166.41, aggressive investors could sell the December $161 put that expires Dec. 10 for about $1.50.

After the Fed concludes its meeting, and the fog somewhat clears from the market, the position could be reset in reflection of the market’s changing dynamics, which are surreal enough to have inspired Salvador Dalí.

Originally Posted on December 2, 2021 – Investors Are Frightened. How to Use Their Fears to Profit.

Updated December 3, 2021 / Original December 2, 2021

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.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from Barron's and is being posted with permission from Barron's. The views expressed in this material are solely those of the author and/or Barron's and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

Disclosure: Options Trading

Options involve risk and are not suitable for all investors. For more information read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD). To receive a copy of the ODD call 312-542-6901 or copy and paste this link into your browser:

http://www.optionsclearing.com/about/publications/character-risks.jsp

trading top