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Have You Considered Options?
With market volatility comes opportunity with options trading – specifically selling options.
A basic trade that investors use is known as a cash-covered put.
Here’s how it works:
By selling a put option I get paid a premium. When volatility is higher, this premium gets larger.
I get to keep this premium no matter what.
If the stock falls below the strike price by expiration, I will end up buying (being assigned) 100 shares of stock per contract I sell at the strike price.
If the stock stays above the strike price by expiration, the contract expires worthless and I get to keep the premium.
Now, the thing to remember is that when I sell the put, I have to set aside the money as if I was going to buy the stock. So, you need to think about it as a return on investment.
Investors use this strategy to lower the price of entry on a stock they want to own. That way, they get paid to wait.
Here’s an example using Apple (AAPL):
The reason this type of trade works well at the moment is because you get paid a higher premium when volatility is higher like it is now.
Are There Still Deals in This Market?
Stocks sold off hard the last few weeks with technology leading the way.
Right now, investors are scratching their heads wondering where they can invest their money.
Over the next few years, banks will find themselves in a fantastic environment to make more money.
Although many of the earnings calls from JP Morgan (JPM) to Citigroup (C) spoke of higher salaries, most expect higher rates to offset those costs and then some.
Higher interest rates increase the spread between the rates banks pay to borrow and lend money, known as net interest margin.
Regional banks (KRE) derive a larger percentage of income from net interest than Wall Street banks with other divisions such as trading.
Financials are killing the broader market this year with year to date performance as follows:
Investors like to hide money in ‘safer’ stocks when markets turn nasty.
Consumer Staples (XLP) fit this bill. This includes companies that provide basic essentials such as grocery stores like Kroger (KR), fast-moving consumer goods like Clorox (CLX).
Last year’s winners are still making a strong showing in 2022.
Energy stocks (XLE) are up more than 17% year to date as natural gas supplies remain in doubt and crude oil prices continue to rise.
This theme is likely to continue through the winter and if we have a hot summer, the rest of the year.
Avoid Dividend Stocks
While dividend stocks might seem like a good place to stash money, higher interest rates make them less attractive.
Think of it this way.
A 10-year treasury bond pays 0.5%. You put a 3% risk premium on a dividend stock and will only buy it when the yield is 3.5%.
Higher interest rates push the 10-year Treasury yield up to 1.5%. Now, you require a 4.5% dividend yield on the stock. Assuming the dividend payment remains the same, you need the stock’s price to drop by ~22% to make that happen.
The Bottom Line: When markets drop, they can and do take most sectors down. However, as investors, we want to own those set to perform better over the next year rather than trying to pick the bottom on technology companies.
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