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A Fed Policy Shift Could Be Near. Buying Bank Stocks Looks Like a Good Strategy.

Federal Reserve Chairman Jerome Powell.

Susan Walsh/POOL/AFP via Getty Images

By the end of August, we may learn if the golden era of investing will sink into a bronze age.

Federal Reserve Chairman Jerome Powell could more definitively signal an end to the easy-money policies that have propelled the equity market ever higher over the past 21 years, at the Fed’s annual summer gathering in Jackson Hole, Wyo., on Aug. 26-28. Such a shift could make it harder to thrive in the stock and options market.

Powell and other central bank leaders have already indicated that monetary-policy changes are forthcoming, but investor expectations have intensified before the policy symposium. The Jackson Hole meeting is always a major event, but this year might top them all as the S&P 500 index is at record levels and the Covid-19 pandemic remains a menace to the world’s well-being.

Everyone knows the headline facts, of course, but it’s likely that many investors aren’t positioning around the meeting.

Instead, the market mob remains broadly focused on short-term, event-driven trading based on earnings reports and economic data. Then there is the constant palaver over meme stocks, and the triumphs and perceived tribulations of Cathie Wood’s ARK Invest and Elon Musk’s Tesla (ticker: TSLA). Substantive matters that can’t be discussed with emojis tend to be sidelined—until they aren’t.

Proactive investors should consider making moves in the rate-sensitive financial sector in anticipation that something significant could happen at Jackson Hole.

Investors who agree with this thesis can buy the primary proxy for the financial sector, the Financial Select Sector SPDR exchange-traded fund (XLF). The ETF hit a high in early June and has done so again this week—and now, at $38.80, it seems poised to try to move into a higher trading range.

The ETF is up about 56% over the past year, and it could go higher if interest rates spike. Yes, there is the risk that some investors might decide that the ETF’s past year’s gains are reason for profit-taking, but that lacks economic sense in a higher-rate environment. Banks make more money when rates are higher.

Even if nothing happens at Jackson Hole, the financial sector is likely to become even more important in anticipation that something meaningful may happen at the year’s final three meetings of the Fed’s rate-setting Federal Open Market Committee.

The Financial Sector ETF position can be enhanced with options. Investors who are bullish on the ETF can simply sell cash-secured put options to position to buy shares at lower prices. The October $37 put, for example, enables investors to buy the ETF at $37 or to pocket the 69-cent premium if the ETF is higher than the strike at expiration.

Investors looking to increase their returns can buy call options with strike prices that are slightly above the stock price. The September $40 call, recently trading around 39 cents, would be worth $2 if the ETF is at $42 at expiration.

During the past 52 weeks, the ETF has ranged from $22.94 to $38.81.

Investors should be mindful of the FOMC meetings scheduled for September, November, and December. Take extra care to identify the events that are packed into each options expiration. Such tradecraft always matters, especially if a policy shift is near.

For the past two decades, the Fed’s liberal policies have protected the stock market. Terrorist attacks, the worst financial crisis since the 1929 crash, a viral pandemic, endless wars, and political intrigue all failed to impede the stock market’s rise. The amount of wealth that has been created has been staggering—so stay agile. You want to be ready to alter course when the Fed changes the rules of the game.

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.

Email: [email protected]

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