Self-reliance. Cunning. Stoicism. Forethought of action.
Those qualities are perhaps the best response that investors can have as Democrats and Republicans posture about what they need to permit a temporary fix to the debt ceiling.
Most people apparently think politicians aren’t reckless enough to let the U.S. default on its debts, yet investors’ market positioning suggests they may not be so sanguine. They are seemingly adopting a trust-but-verify approach as they watch Washington.
Hedge funds, which are often among the most sophisticated investors, are up about 3% so far this year, largely because they bought hedges to protect against stock declines, Goldman Sachs recently told clients. Their underperformance compared with the
S&P 500 index’s
almost 10% year-to-date return shows that the market is still complacent about a debt-ceiling crisis.
Similarly, trading patterns in the options market lack conviction. It still makes sense to let the market reveal itself before making any major decisions, even if it limits potential gains that come from correctly anticipating a market turn.
If stocks tumble on debt-ceiling news, investors could respond to a potential selloff by selling cash-secured put options on blue-chip stocks that they want to buy and hold for three to five years.
Conversely, if stocks rally on a debt deal, investors could sell call options on stocks that they own to enhance returns.
These trading strategies are intended to monetize fear and greed paroxysms. They also reflect a view that when the debt crisis ceases to be a primary market risk, investors will refocus on structural challenges that are confronting the economy and that may adversely impact corporate earnings.
Those risks, which seem quaint compared with Washington’s histrionics, include inflation, employment, and the future of the Federal Reserve’s rate hikes. The Federal Open Market Committee concludes its next rate-setting meetings on June 14 and July 26.
If the market refocuses on those risks, investors could look for investments that offer a degree of safety, such as the stodgy utility sector, which could benefit if investors decide that return of capital, rather than return on capital, is more important.
The
Utilities Select Sector SPDR
exchange-traded fund (ticker: XLU), which yields about 3.4%, has lagged the stock market even more sharply than hedge funds. So far this year, the ETF is down about 6%.
Almost everyone is fond of noting that they can earn 4% or more in various cash accounts without taking on any equity market risk, but utilities offer an attractive yield and the potential to benefit from a snapback rally.
Intrigued? Consider a “half and half” strategy. If you want to buy 1,000 shares of the ETF, for instance, you could buy 500 shares and sell five puts. The strategy helps you build a position if you are concerned that prices could remain under pressure.
With the ETF around $66, the August $63 put could be sold for about $1.50. The put sale positions you to buy it at an effective price of $61.50, a price that is just above the 52-week low. During the past 52 weeks, the ETF has ranged from $60.35 to $78.22.
Should the ETF be above the $63 put at expiration, you can keep the put premium. Should it be below the strike at expiration, you should buy it and then prepare to sell calls against the position to generate income.
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.
Email: [email protected]
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