The stock and options markets are suffering from what might be called Neropathy. Just as the Roman emperor Nero played his fiddle as Rome burned around his palace, the markets are seemingly oblivious to the pain and destruction that has enveloped much of the U.S. and the world.
Despite massive unemployment and severe economic contractions sparked by an as-yet incurable virus, the Dow Jones Industrial Average and the S&P 500 index are nearing their highest levels ever. Not even days of nationwide protests sparked by the death of George Floyd while he was being arrested in Minneapolis have tarnished the stock market’s momentum.
Tens of thousands of people are demonstrating in the streets, venting their anger about police brutality and social inequities that never seem to go away. President Donald Trump is bellicose. He berated governors for being “weak,” while his defense secretary told them to “dominate the battlespace” in their cities.
Earlier in the week, the Congressional Budget Office warned that it could take more than a decade for the economy to recover from the coronavirus pandemic. Yet the stock market marches ever higher. A key measure of the risk of owning stocks, the Cboe Volatility Index, or VIX, is purring like an innocent kitten that is lapping up dour economic reports like sweet milk.
Some credit the Federal Reserve for rescuing stocks for the second time in a decade with low rates and easy-money policies, but others fret that the mighty “Fed put” could ultimately be overcome by the added risks of the latest events.
Michael Schwartz, Oppenheimer & Co.’s chief options strategist, told Barron’s that he is increasingly struck by the singularity of this moment in market history.
“I have lived through many unique events over the past five decades on Wall Street,” he says, “but this market seems to defy all logic based on historical experiences and data.”
Stock prices are driven by corporate earnings, and earnings are influenced by economic conditions here and abroad. The equity market doesn’t seemingly reflect reality.
Since the S&P 500 bottomed on March 23, it has gained more than 37%, while many stocks and sector funds have experienced more dramatic advances.
Chris Jacobson, a Susquehanna Financial Group strategist, told clients that investors appear eager to look past headwinds including deteriorating relations between the world’s two largest economies, U.S. and China, that should suppress investor enthusiasm to buy equities.
“The market is done with ‘Buy the dip and sell the rip.’ It’s now ‘Buy the dip and buy the rip,’ ” Dennis Dick, a Bright Trading proprietary trader, tweeted on Wednesday.
Many investors are caught in the middle. They aren’t willing to sell and miss this extraordinary rally, but don’t want to put new money in stocks at these high levels. We know that people are curious about how to participate in the stock market without taking on incredible risk. A solution: selling put or call options on the S&P 500.
Calls give a buyer the right to buy stocks at a certain price and time; selling them is a bet on the market’s expected trading range. Puts give a buyer the right to sell stocks at a certain time and price; selling them expresses a view that prices will rally higher.
If the sellers are right, they collect a wad of cash, and if they are wrong, they roll the trade to another month and try again. Tax treatment is favorable—60% of gains are taxed at long-term rates, while 40% are taxed as short-term gains.
The traditional S&P 500 trade is selling puts or calls that are 100 points above or below the index’s level, but some investors are updating the strategy to reflect the current market. They are using strike prices that are 200 points away from the market, reflecting the extraordinary price swings that now define this Neropathic market.
—
Originally Posted on June 4, 2020 – How to Play a Market That Shrugs Off Everything
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from Barron's and is being posted with permission from Barron's. The views expressed in this material are solely those of the author and/or Barron's and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.
Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.
Disclosure: Options Trading
Options involve risk and are not suitable for all investors. For more information read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD). To receive a copy of the ODD call 312-542-6901 or copy and paste this link into your browser:
http://www.optionsclearing.com/about/publications/character-risks.jsp
