Traders at the New York Stock Exchange. The S&P 500 entered correction territory last week.
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Buy fear.
Should the shooting war in Ukraine drag on, stock prices will likely tumble—and perhaps stay there for a while—and bearish options premiums will likely surge.
The combination of battered equities and elevated implied volatility should present long-term investors with opportunities to increase positions in stocks that they own, or to establish positions in stocks they have waited to buy as prices rallied ever higher.
When options premiums are plump, as happens when volatility increases, and stocks are weak, sophisticated investors often sell bearish puts to buy stocks. Puts give holders the right to sell an underlying security at a specified price before a set date.
Selling puts to investors who want to, or must, hedge stocks allows you to profit from the fear that is bullying the stock market. The strategy is an options-centric variation of buying low in one market and selling high in another.
The Cboe Volatility Index, or VIX, is already elevated. The market’s fear gauge was recently around 32, up 86% since the start of the year. Investors should use the VIX as a proxy for the implied volatility levels of S&P 500 stocks.
When the VIX is above 30—a level that often denotes meaningful fear about what will happen to stocks over the next 30 days—bearish options-selling strategies become more attractive than usual.
The VIX’s increase reflects the S&P 500’s fall of more than 10% from its early January high, general consternation about Russia’s invasion of Ukraine, and the Federal Reserve’s expected plans to begin to normalize monetary policy at its March 15-16 meeting.
The more the VIX rises, the more expensive puts should become, as investors will likely rush to hedge their stocks, often paying any price to buy puts, which increase in value as stock prices decline. Such price insensitivity is often a bullish sign for stocks.
Hedging has occurred since late summer, first among the most-sophisticated investors. Now it is so widespread that it is even appearing in news reports.
If all of the market machinations had to be reduced to a simple phrase, remember this jingle: When the VIX is high, it’s time to buy. Let VIX above 30 be your trigger.
Everyone likely has a list of stocks that they want to buy at the right price, or that they want to own even more of. Until recently, buying stocks meant trading at the top, or near the top, of historically high prices. But the expectation of rate hikes, and now geopolitical concerns, has more than muted the market’s momentum.
Rather than picking a single price point to trade, investors can ladder strikes. The strategy entails selling puts with different strike prices to position to buy at lower and lower prices. Consider the SPDR S&P 500 exchange-traded fund (ticker: SPY).
Long-term investors who want to take advantage of short-term market volatility could sell puts that expire in one month and that are, say, 5%, 7%, or 10% below the ETF’s stock market price.
Should the ETF snap higher, investors can keep the premium. Should the ETF be below the put strikes at expiration, investors are obligated to buy the ETF.
The trade expresses confidence in American ingenuity and industry, which are some of the greatest forces the world has ever seen. Our leading stocks have long led the world. Monetizing fear to acquire blue-chip stocks has historically been a good idea for long-term investors.
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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