Federal Reserve Chairman Jerome Powell at a news conference in Washington on May 4.
Jim Watson/AFP via Getty Images
Jerome Powell’s recent news conference lingers like a traumatic Zen koan. The Fed chairman said one thing, but what if it means something else and even he doesn’t realize it?
Powell affably told the reporters who follow him around that the Federal Reserve isn’t actively considering an interest-rate hike of three-quarters of a percentage point. Beginning the next day, the stock market has convulsed sharply lower as if the vast majority of investors think he cannot control inflation with only half-point rate hikes. The Cboe Volatility Index, or VIX, has surged above 30, a level that reflects widespread fear that the S&P 500 index will keep falling over the next month.
Remember when former Fed chief Alan Greenspan—who never seemed to doubt anything—admitted during the 2007-09 financial crisis that his view of the world was wrong? Powell might be forced by inflation data to change his mind about the magnitude of future rate hikes. If the Fed becomes more hawkish than he has conveyed, he might be careening into a Greenspan moment without really knowing what he has gotten himself into.
Investors must now ponder Powell’s estimation of his ability to tamp down inflation with half-point hikes. After all, inflation is surging and some of the causes are beyond anyone’s control, including the recent weaponizing of commodities, China’s relentless bellicosity, Covid-19, and Russia’s invasion of Ukraine. Is it possible to temper those wild forces with 50-basis-point rate hikes, as the Fed apparently believes?
The debate about what might happen next has come to dominate the market narrative. Corporate earnings season is still afoot, and though the results have been reasonably good, no one really cares. It’s the future that matters.
The effortless rallies that largely characterized the stock market since March 2009 belong to history. The Fed put, as we have long predicted, has expired. Investors are no longer encouraged by the Fed’s easy-money policies to venture further and further onto the so-called risk curve. Risk is now something that must be managed rather than embraced.
One way to manage risk is to sell call options on stocks you own, a strategy known as covered-call writing. Selling those calls will generate some income and even hedge the stock by the amount of money received for the sale. When the VIX is high, investors generally get paid more for selling options than when the VIX is low.
The standard approach to this conservative strategy is to sell calls that are about 10% higher than the associated strike price. Pick calls that expire in six weeks or less. The goal is to sell calls that are ideally trading for at least $1, or that represent a significant percentage of the associated stock price. Many investors use the strategy to generate income and reduce risk.
Consider Tyson Foods (ticker: TSN), a stock we have previously highlighted as a way to benefit from inflation. The company just reported earnings and the stock rose on the news.
With Tyson shares at $90.20, investors could sell the June $100 call for about 60 cents. If the stock is below the strike price at expiration, investors can keep the call premium. Should the stock price exceed the strike price, investors are obligated to sell the stock at the $100 strike, or they can roll the call to another expiration to avoid assignment.
The great risk to the covered-call strategy is that the stock price surges far above the strike price. The risk of that is arguably low in the current macro environment, but don’t let that create false confidence. You don’t want your own Greenspan moment. b
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.
