Text size
The Health Care Select Sector SPDR ETF comprises major medical companies that make products many people cannot live without.
Octavio Jones/Getty Images
It could be the single most important question facing investors: When will the bad news that is bullying stocks and bonds be fully priced in?
The answer is as elusive as it is critical, and that makes it intriguing to long-term investors who are comfortable wrestling with time and volatility rather than watching them wreak havoc on their portfolios.
Meanwhile, Wall Street and the financial media lately have become awash with all sorts of bullish prognostications about what happens after the
S&P 500 index
officially enters a bear market, which it did earlier this week.
So far, most investors haven’t taken advantage of the stock market’s surreal weakness, even though equity prices are sharply lower this year and options volatility is sharply higher. Instead, they were being held hostage by fears that the Federal Reserve would become more aggressive to regain mastery over the economy—and the Fed’s rate-setting committee answered by raising the federal-funds rate by 0.75 percentage point.
Rather than waiting for all of this to play out, investors with a contrarian temperament can try to define the market bottom themselves with cash-secured put option sales. By selling puts that are 5% to 10% or even further below stock and index levels, investors can anticipate tomorrow’s prices today. (Puts give holders the right to sell an asset at a specified price and time.)
Of course, investors who can afford to hold stocks for long periods could simply buy stocks at these weakened levels—as many did on the day of the Fed announcement—but it might prove more profitable to monetize investor fear.
Many options are inflated with fear premiums after the recent stock turmoil. The
Cboe Volatility Index,
or VIX, is close to 30, well above its long-term average of 19. Anyone who sells puts essentially monetizes the fear of other investors. Think of such put sales as getting paid by the options market for entering a good-til-cancelled order in the stock market.
Consider the
Health Care Select Sector SPDR
exchange-traded fund (ticker: XLV), which comprises major medical companies that make products many people literally cannot live without. Its dividend yield is 1.56%.
With the ETF at $121.75, the September $118 put could be sold for about $4. Should the ETF remain above the put strike price, investors can keep the put premium. If it falls below the put strike, investors are obligated to buy the ETF, or to roll it to a future expiration cycle to avoid assignment.
The put positions sale investors to buy the ETF at an effective price of $114, which is 6% below the current price. During the past 52 weeks, it has ranged from $119.67 to $143.42. It is down 14% so far this year.
Cash-secured puts aren’t for everyone. Paying less for assets will appeal to many people, but selling downside puts when there is fear of an economic recession is even more aggressive than it might seem. Selling puts is essentially running into a fire when everyone else is trying to exit. Consider the strategy only if you have enough money to buy the stock at the strike price.
The great risk to selling cash-secured puts is that the underlying security keeps sinking. Only very tough, committed investors ever feel good about buying stocks when an asset is below the put strike price.
For that reason, only sell puts on securities that you are willing to own and that you can afford to warehouse for three to five years. If you cannot accept those terms, you are gambling on short-term stock swings rather than attempting to bend stock prices to your terms.
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]
.