Traders at the New York Stock Exchange.
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Anyone who predicted that a pandemic would be followed by events that might spark World War III is probably in direct communication with the Creator or the Devil.
Just as we thought the Covid-19 crisis was ending, Russia invaded Ukraine, and militaries that have long focused on battling terrorism might now be drawn into a land battle in Eastern Europe between a superpower and a smaller, but fierce, nation.
Meanwhile, China, the world’s second-largest economy, is being hit with Covid outbreaks that might once more rattle the global supply chain. Inflation is surging everywhere, and the world’s central banks, which have long embraced easy-money policies that have also boosted stock prices, are raising interest rates. Federal Reserve Chairman Jerome Powell just said he was open to raising rates by half a point at each of the next two meetings if circumstances dictate it.
For investors, these are truly extraordinary times, perhaps the most treacherous since the 2007-09 financial crisis. But this time, the Fed is in exactly the spot that many feared: confronting rising inflation and geopolitical risks while normalizing monetary policy. The so-called Fed put has expired, and the full contour of the bank’s tools is unclear.
In the absence of a direct connection to celestial or subterranean power(s), we turn to Oppenheimer’s Michael Schwartz. The dean of Wall Street’s options strategists, he has been in the options market since 1965.
Schwartz said that his experience has taught him, time and time again, that investors should use fear and volatility to their advantage as often as they can.
“Look at Warren Buffett, who has been at this longer than almost anyone. He was quiet for so long, but now he’s active and buying companies and investing when so many others are worried about what comes next,” Schwartz told Barron’s.
Schwartz said that investors should watch the Cboe Volatility Index, or VIX, and wait for it to spike higher. If that happens, it would be a sign not only that the stock market is sharply lower—but also that investors are afraid of what comes next.
The VIX has plummeted since the Fed’s March meeting, suggesting that some calm has returned, but trading patterns in the stock and options markets are erratic and held hostage by the next news cycle out of Ukraine or some economic report.
Proactive investors should create a list of dividend-paying blue-chip stocks they would be willing to buy at lower prices. Similarly, Schwartz says investors should review stocks they own and identify those that they are willing to sell higher to secure profits.
“Volatility often scares people, but it can be one of the best friends that a long-term investor can have,” he says.
By selling puts when VIX is surging—a level of 35 or higher would denote real fear—investors can monetize the fear premium and get paid by the options market to buy stocks at lower prices. Similarly, by selling calls on stocks that an investor already owns, it’s possible to monetize the erratic rallies that often inflate call premiums.
Structuring options strategies is a bit of art and a bit of science. Most investors sell puts and calls that expire in one to three months and have prices that are about 10% away from the associated stock’s price.
The risk to selling cash-secured puts is that a stock plummets far below the put strike price. The risk to selling calls is that the stock surges above the call strike price.
“It’s impossible to time the markets,” Schwartz says, “but anyone can use volatility like a rubber band to help hold together their portfolios or to help them make buy and sell decisions.”
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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