Is The COVID Bear Sleeping or Waiting to Pounce?
When I tell my twin toddler grandsons an inconvenient truth, such as “It’s time for bed,” they sometimes put their hands over their ears and pretend not to hear.
Sort of like Wall Street and its stance toward the coronavirus pandemic.
In my view, we’re not out of the woods with COVID-19 and stocks are due for additional pullbacks over the near term. The bear isn’t back in hibernation; it’s lurking behind a tree. Maybe we’ll only get a correction of about 10% and not a full-fledged bear market crash. Regardless, this rally doesn’t seem sustainable.
Below, I explain a time-proven options trading strategy for taking advantage of market downturns. But first, let’s examine the facts, without the “magical thinking” of pundits and pols.
Investors and political leaders are champing at the bit for a return to business as usual. However, despite their state of denial, the coronavirus pandemic remains a deadly reality.
As of this writing Wednesday morning, the COVID-19 death toll has reached about 351,000 globally and nearly 100,000 in the United States. Epidemiologists warn that the virus won’t simply vanish due to warmer summer temperatures.
Nor can we talk the virus away. Just because someone appears on cable news and says everything is fine doesn’t make it so. The talking heads on media venues such as CNBC, Bloomberg, Fox Business, and the rest often aren’t financial experts. They’re certainly not scientists. Typically they’re generalists and performers who are trying to manufacture a public consensus around a preconceived agenda.
Back in February, numerous talking heads on television were asserting that the coronavirus had been contained and the economy would hold up nicely.
The financial media right now are trumpeting a bullish tone, despite the worst economic data since the Great Depression. My contrarian impulses are flashing a red alert.
The hasty pace of re-openings might backfire and trigger a second wave of coronavirus cases, which in turn would traumatize the public and send the economy into even deeper contraction.
And yet, since their March coronavirus lows, stocks have rallied with large-caps leading the way. A handful of mega-cap Silicon Valley stalwarts have been in the vanguard. In recent days, small-capitalization stocks have demonstrated relative strength, which means the rally is finally showing breadth. Along with the main indices, the Russell 2000 has surged to a new 10-week high.
The three main U.S. stock benchmarks soared Tuesday, fueled by optimism over the easing of lockdowns. The Dow Jones Industrial Average rose 2.2%, the S&P 500 climbed 1.2%, and the NASDAQ edged up 0.2%. In early trading Wednesday, the three indices were extending their gains.
The Memorial Day weekend saw crowds returning to parks and beaches and the incremental reopening of businesses, under guidelines that vary from state to state. Also underpinning bullish sentiment are promises from Congress of further stimulus.
European stocks, especially the beleaguered banking sector, are getting a lift from the European Union’s announcement on Wednesday of a new stimulus initiative. All of the 27 member states still must ratify the package worth €750 billion ($823 billion), but the news is a tailwind for businesses and investors on the Continent.
A headwind is the Sino-American trade war. The U.S. government continues to confront China with sanctions, especially in the wake of China’s harsh new security laws for Hong Kong. Last week, the U.S. threatened to delist Chinese companies that don’t submit to third-party audits.
If the trade war intensifies, it could choke off the rally. It’s also worth remembering that most tariffs implemented since the start of the trade war in January 2018 remain in effect.
Crude oil prices have been rising, on increasing confidence that oil producers are honoring their obligations to reduce output and as energy demand picks up. West Texas Intermediate (WTI), the U.S. benchmark, currently hovers at $34 per barrel, a far cry from its negative price of -$37.63/bbl on April 20. That said, WTI is still down year-to-date by 46% (see chart).
The energy bulls are overlooking the fact that the work-at-home trend that accelerated during the pandemic will continue to weigh on fossil fuel demand.
What’s more, $30/bbl oil still isn’t high enough to save the massively indebted U.S. shale industry. The big winners in the post-pandemic world will be solar and wind power and other renewable sources of energy.
Another winner will be the technologies that expedite the rising home office culture, such as ultra-fast wireless capabilities. The pandemic has forever changed consumer behavior. Accordingly, investors need to change their focus.
In a down market, you have options…
Part of my recommended investment strategy is to buy stocks at cheap prices during fear-induced general market selloffs. Options can facilitate this strategy.
For buying stock cheap during fear-induced slumps, consider selling puts. For example, let’s say you’d love to buy a stock if it fell in price to $30. Rather than place a limit order to buy 200 shares at $30, you could sell two put options with a strike price of $30 for, hypothetically, $2 per share. If the stock closes below $30 at expiration, the put option would be exercised by the put buyer and you’d be required to buy 200 shares of stock at the $30 strike price.
The benefit of buying your stock through option exercise rather than a limit buy order is that you get paid an additional $2 per share in income, making your net purchase price only $28.
The great thing about this option-selling strategy is that you can rest easy without worrying about options expiring worthless. You aren’t speculating on stock movement within a limited time period. Regardless of how the underlying stock price moves, selling options reduces the cost and downside risk of your stock ownership.
The only risk, if you can call it that, is you will make less money than straight stock ownership if the stock price skyrockets upward. But missing out on a speculative upside gain is much less painful than losing money…especially under today’s crazy conditions, with the Dow posting wild swings up and down.
I’ve only outlined one options trading strategy. For the best options advice available, turn to my colleague Jim Fink.
Jim Fink is the chief investment strategist of Velocity Trader, Options for Income, and Jim Fink’s Inner Circle.
Jim has developed a proprietary options trading method that consistently beats Wall Street at its own game, in markets that are going up, down or sideways.
Jim is making this bold promise: if you agree to give him your mailing address today, he’s willing to give you $1,000 to prove that his trading system works. Want to take him up on his offer? Click here for details.
John Persinos is the editorial director of Investing Daily. You can reach him at: firstname.lastname@example.org