It’s the start of the most important earnings season in a decade.
The stock market just posted its greatest weekly rally in 46 years. But that fact—and even official government reports—will be less valued by investors than first-quarter earnings reports, which will provide reasonably solid data to evaluate what has happened to the economy since the coronavirus threw it for a loop.
Everywhere one turns, someone is confidently asserting what we will want to hear: that the worst is truly over. Often, the soothsayers cite the lowered level of the Cboe Volatility Index, or VIX, as if that alone will magically heal the global economy and even repel the Covid-19 virus. Yet recent earnings reports from Bank of America (ticker: BAC), JPMorgan Chase (JPM), Wells Fargo (WFC), and others suggest much suffering ahead , even if the fear gauge is falling.
The options market, where sophisticated investors position for the future, is displaying a cautiousness that contradicts some of the recent stock-market strength. Indeed, strategists at Goldman Sachs, J.P. Morgan, and Oppenheimer & Co. are advising clients to focus on conservative strategies.
“We are in the middle of a golden age for options-selling strategies. Premiums are widely inflated with fear, and this is creating intense interest among investors to sell puts and calls,” Michael Schwartz, Oppenheimer & Co.’s chief options strategist, told Barron’s.
J.P. Morgan’s Shawn Quigg recently told clients that investors seem reluctant to do anything too risky, though they are interested in “monetizing rich implied volatility levels by overwriting long stock positions.”
Earlier this week, trades that attracted attention involved major investors “overwriting” large stock positions. The strategy entails selling calls —usually at 5% to 10% above a stock’s price and that expire in under three months—against stock that an investor owns.
Overwriting pays investors for owning stock and for agreeing to sell at the higher price should the stock price exceed the strike price at expiration. Many investors, however, don’t want to sell their stock, so they perpetually “roll” the calls to higher strike prices to hold the shares and keep generating more income.
This will annoy some investors who feel cheated if they are not offered complicated strategies that allow them to intellectually strut their stuff. But it’s a message worth heeding when top strategists and major investors are keeping it simple.
Susquehanna Financial Group’s Chris Jacobson cited the sale of 20,000 Target (TGT) June 120 calls, 10,000 Citigroup (C) June $60 calls, 10,000 Morgan Stanley (MS) June $50 calls, 10,000 Duke Energy (DUK) June $100 calls, and 10,000 Honeywell International (HON) June $165 calls.
Favorite J.P. Morgan call-selling candidates include Starbucks (SBUX), General Electric (GE), Lowe’s (LOW), and Darden Restaurants (DRI). Other S&P 500 index overwriting candidates include Boeing (BA), Chipotle Mexican Grill (CMG), Nordstrom (JWN), Twitter (TWTR), Deere (DE), Ulta Beauty (ULTA), Dow (DOW), Schlumberger (SLB), and Exxon Mobil (XOM). Quigg told clients to focus on call options that expire within two months with strike prices 5% higher than the underlying stock prices.
Even though officials are contemplating reopening the economy, and the Federal Reserve is battling to rescue the economy for the second time in a decade, many options investors are cynical. Trading suggests that stocks may advance, but more slowly, as companies release earnings reports and the information is digested. Some investors are hedging against declines, too.
In some ways, option trading patterns are playing a dirge for a damaged economy. When will we know the worst is over? When Warren Buffett invests his massive cash pile and it’s easy to buy name-brand toilet paper on Amazon.
Originally Posted on April 16, 2020 – The Stock Market’s Fear Gauge Is Down, but Earnings Season Could Change All That
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