By Steven M. Sears
Sept. 25, 2024
Investors are enjoying a pinnacle economic moment. Many people have never been so wealthy. Anyone who has handled their investments with a modicum of good sense has a brokerage account balance at, or near, record highs.
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The good times could get better. The U.S. Federal Reserve, which is to markets what the North Star is to celestial navigation, indicated that its recent half-point interest rate cut would be the first of many. Low rates lower the cost of capital, and that tends to increase stock prices.
Alas, this happy moment could be disrupted by some powerful forces.
Though Wall Street's marketing machinery has never encountered a time when it didn't think everyone should buy stocks, the people who buy and trade stocks for Wall Street will soon develop an aversion to investment risk. The bulk of their income is paid in annual bonuses, which will soon be distributed, and they will do nothing to damage those bonuses—such as exposing themselves to a lot of risk by buying stocks trading at record highs.
Seasonality is another risk. The month of October commemorates the market's worst historical performances. Individual investors may be emboldened by their recent success to buy whatever market weakness emerges, as such boldness has long been rewarded. But dip buyers could struggle if Wall Street's risk takers, who provide force to the market's trading patterns, watch from the safety of the market's sidelines.
These disparate forces have the making of a witch's brew—and they coincide with a warning from John Marshall, Goldman Sachs' influential derivatives strategist. He has told clients that market volatility is lower than is warranted.
Based on his economic model, the Cboe Volatility Index, or VIX, should be 24.5. Instead, the so-called fear index is around 15.5, suggesting investors are too sanguine. The VIX historically averages 22 points in October. Marshall suggested clients buy VIX November $18 call options—a bet that volatility will increase.
Most individual investors should ignore VIX options. Dealers too heavily influence VIX options prices, and too few investors understand how VIX futures influence VIX options.
That brings us back to what should interest you most: your money. Think about protecting your unrealized gains—and profiting from potential market volatility when stock prices are elevated—with a strategy called "ratio put spreads" on the S&P 500 index.
They increase in value if the stock market declines, and they pay investors to buy stocks at lower prices.
The strategy sounds obtuse, but it is simply a combination of a standard put spread that has been enhanced with an extra cash-secured put. (A put sale obligates the seller to buy shares at a set price within a set period; "cash secured" means you have set aside the funds to purchase the shares.)
The strategy has something for short- and long-term investors, but the outcome isn't guaranteed.
We mention this as a reminder that suggesting a clever trading strategy is easier than making money. Still, if memory serves, there was once a time when stocks didn't always rise. Right?
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