Federal Reserve meetings come and go, but time and volatility last forever.
Investors should be mindful of that fact and consider using short-term volatility to advance long-term goals, rather than obsessing over what is right in front of them.
The options market enables anyone who wants to use what we have long called “time arbitrage” to take advantage of short-term weakness in stocks in the pursuit of long-term investment objectives.
By selling put options, which tend to increase in value when stock prices are weak, you can get the options market to pay you to be a long-term investor. (Puts give buyers the right to sell an underlying stock at a specified price within a set period.)
Consider the recent activity in the stock and options markets. Options volatility surged, and many stock prices tumbled, in anticipation that the conclusion of Wednesday’s meeting of the Federal Open Market Committee could signal the end of the great, historic bull market.
As was largely expected, the Fed signaled once more that the March meeting could mark the first in a series of rate hikes, essentially ending decades of low rates that have propelled stock prices to record highs.
Stock prices were extremely erratic into the meeting, and even after, vexing many investors. The Cboe Volatility Index, or VIX, has almost doubled since the start of the year, rising from about 17 in early January to about 32 as the stock market weakened.
The VIX’s current level is significantly higher than its long-term average of 19. Options premiums are now inflated with meaningful fear premiums that investors may be able to use to their ultimate advantage.
You can pick almost any stock in this strategy, but we tend to favor well-run, blue-chip companies with demonstrated staying power and good management teams. Those attributes tend to spawn worthy long-term holdings—even if their prices whip about from time to time.
Consider Morgan Stanley (ticker: MS), one of the world’s top investment firms. The company just reported better-than-expected earnings, and it is well-positioned to thrive amid the volatility that will probably accompany the Fed’s normalization of monetary policy. Moreover, banks often profit from rising interest rates and financial market volatility. The bank, like its peers, faces rising compensation expenses, but even that is likely to be short-lived.
With Morgan Stanley stock at $100.17, long-term investors could sell the March $97.50 put for about $4.10.
The sale of a cash-secured put obligates investors to deposit the money they need to buy the stock in a cash account with their broker. The strategy then lets them position to buy the stock at a lower price, or to keep the options premium should the stock advance. The trade can be done in a margin account, but be sure you have enough money available to finance the transaction.
If Morgan Stanley stock is at $100 at expiration—perhaps the stock market goes nowhere, or concerns about rising bank expenses keep investors away—you can keep the options premium.
Should the stock be at or below the $97.50 strike price, investors are obligated to buy the stock or to adjust the position in the options market to avoid assignment.
The great risk to the strategy is that the stock plummets far below the put strike price. Only consider the cash-secured put sale if you are willing to buy the stock at a discounted price.
During the past 52 weeks, Morgan Stanley stock has ranged from $66.85 to $106.47. It has barely budged this year, though it rose 43% in 2021, sharply outperforming the S&P 500 index’s return.
Originally Posted January 27, 2022 – This Options Strategy Pays You to Buy Stocks for the Long Run
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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