Seeing Beyond The Black Swan Event

Just before the COVID-19 pandemic struck the S&P 500, Nasdaq, and Dow, Ray Dalio was recklessly dismissive of cash positions, stating "cash is trash." Even Goldman Sachs proclaimed that the economy was recession-proof via "Great Moderation," characterized by low volatility, sustainable growth, and muted inflation. Not only were these assessments incorrect but they were ill-advised in what was an already frothy market with stretched valuations. I'm sure Ray Dalio quickly realized that his "cash is trash" mentality, and public statements were imprudent. The COVID-19 pandemic has been a truly back swan event that no one saw coming. This health crisis has crushed stocks and decimated entire industries such as airlines, casinos, travel, leisure, and retail with others in the crosshairs.

The S&P 500, Nasdaq, and Dow Jones have shed approximately a third of their market capitalization, with the sell-offs coming in at 33%, 29%, and 36%, respectively, through March 20, 2020. Some individual stocks have lost over 70% of their market capitalization. Other stocks have been hit due to the market-wide meltdown, and many opportunities have been presented as a result.

Investors have been presented with a unique opportunity to start buying stocks and take long positions in high-quality companies. Throughout this market sell-off, I have begun to take long positions in individual stocks, particularly in the technology sector and broad market ETFs that mirror the S&P 500, Nasdaq, and Dow Jones. It's important to put this black swan into perspective and see through this on a long term basis while viewing this as an opportunity that only comes along in decades.

Most Extreme and Rare Sell-Off Ever

The abrupt and drastic economic shutdown and velocity of the U.S. market's ~30% drop within a month bring parallels to the 1930s. This sell-off has been extreme and rare in its breadth, nearly evaporating entire market capitalizations of specific companies. The pace at which stocks have dropped from their peak just last month from all-time highs is the fastest in history. The major averages just posted their worst week since the financial crisis (Figures 1 and 2). The Dow is tracking for its worst month since 1931, the S&P since 1940. As of March 20, the S&P 500, Nasdaq and Dow Jones have sold off 33%, 29%, and 36%, respectively. Continue reading "Seeing Beyond The Black Swan Event"

Don't Be Remiss - Start Buying Stocks

The coronavirus (COVID-19) epidemic has pummeled stocks and has caused a complete collapse of the entire market. Broader indices such as the S&P 500, Nasdaq, and Dow Jones have lost over 20% of their value, while most individual stocks have lost 20%-70% of their market capitalization. Airlines, cruise lines, and casinos have been hit particularly hard. Other stocks have been hit due to the market-wide meltdown, and many opportunities have been presented as a result. I'd be remiss if I didn't use this unique opportunity to start buying stocks and take long positions in high-quality companies. Throughout this market sell-off, I have begun to take long positions in individual stocks, particularly in the technology sector and broad market ETFs that mirror the S&P 500, Nasdaq, and Dow Jones.

The Financial Crisis and 1987 Black Monday Comparators

The broader market sold off in a historic downward move as the coronavirus has spread outside of China throughout the rest of the world, effectively shutting down economic activity on a grand scale. During the last week of February, the Dow Jones and S&P 500 sank by 12% and 11% for the week, respectively. This marked the worst weekly performance since the financial crisis for the markets. The Dow posted its biggest one-day loss ever during the week and tumbled into correction territory, down more than 10% along with the S&P 500 and Nasdaq.

As the markets moved into March, the S&P 500 officially closed in a bear market on March 12th, down more than 26% from its record high set just last month. This ended the historic 11-year bull market run. The Cboe Volatility Index (VIX) jumped to more than 76 and hit its highest level since 2008 (Figure 1). On March 12th, The Dow Jones and S&P 500 had its worst drop since the 1987 "Black Monday" market crash, when it collapsed by more than 22% (Figure 2).

This market-wide meltdown is in response to the negative impact that COVID-19 will likely have on the global economy and corporate earnings. A wide array of companies have already issued warnings about their upcoming quarterly earnings. This placed a damper on the outlook for the markets, especially with rising concerns Continue reading "Don't Be Remiss - Start Buying Stocks"

Capitalizing On The Coronavirus Induced Volatility

The Coronavirus has become the black swan event that has materialized into worldwide hysteria. The spread of viruses globally has halted supply chains, commerce, retail, and specifically the travel and leisure sector. The Coronavirus has been the catalyst for the overall indices to drop double digits or ~13% over the course of roughly a one week period in late February. The coronavirus event induced extreme global market volatility that hasn't been seen since Q4 of 2018. This extreme volatility provided options traders with a vast landscape of stocks that possessed rich option premium pricing.

As volatility spikes and stocks sell-off, options traders can sell options and collect rich premium income in a high probability manner with a statistical edge and expected outcomes. Even better, options can be sold with defined risk while leveraging a minimal amount of capital to maximize return on investment (ROI). Whether you have a small account or a large account, a defined risk (put spread) strategy enables you to leverage a minimal amount of capital, which opens the door to trading virtually any stock on the market.

Volatility - Options Trading Edge

The Coronavirus injected volatility across the entire market throughout February and into early March. This volatility resulted in rich option premium pricing, which enabled options to be sold on a wide array of uncorrelated tickers that can be spread over various expiration dates.

Selling put spreads is a great way to leverage a minimal amount of capital while maximizing returns. A put spread is a type of options trade that risk-defines your trades and involves selling and buying an option. These types of trades maximize return on capital; often, a ~10% realized gain over the course of a month-long contract with an ~85% probability of success. The required capital is equal to the maximum loss, while the maximum gain is equal to the option premium income received. Continue reading "Capitalizing On The Coronavirus Induced Volatility"

Put Spread Options - Defining Risk and Maximizing Returns

As 2020 unfolds and the markets continue to break through record highs, investors should heed these lofty levels. We’re in the longest bull market in history and the U.S. has started and ended a decade without a recession for the first time in history. By nearly all measures, these markets are overvalued with stretched valuations.

Deploying a put spread strategy is a great way to define your risk while leveraging a minimal amount of capital to maximize returns. Whether you have a small account or a large account, a put spread strategy is an effective way to limit risk with a high probability of success. Trading options on stocks like Expedia (EXPE), Tesla (TSLA), Ulta Beauty (ULTA), Apple (AAPL), Disney (DIS), Facebook (FB), etc., that possess such a high price per share when account balances are limited are no longer an issue with put spreads. Put spreads enable you to leverage a minimal amount of capital, which opens the door to trading virtually any stock all while defining your risk.

Over the past 13 months, ~315 trades have been made with a win rate of 86% and a premium capture of 57% across 69 different tickers. When stacked up against the S&P 500, an options strategy generated a return of 9.1% compared to the S&P 500 index which returned 3.7% over the same period. These returns demonstrate the resilience of this high probability options trading in both bear and bull markets. These results can be replicated irrespective of account size when following the fundamentals outlined below.

Put Spread and Defining Risk

Options can be used in a leveraged manner hence using small amounts of capital to trade what otherwise would require much greater capital requirements. A put spread is a type of options trade that risk-defines your trades and involves selling and buying an option. Let’s review a put spread below.

The Put Spread: Continue reading "Put Spread Options - Defining Risk and Maximizing Returns"

Options-Based Portfolio: 50% Cash and Matching S&P 500 Returns

2019 shaped up to be a historic year for the stock market indices. The S&P 500 posted its fourth-best annual return in over 20 years, coming in at a ~29.5% return (my options-based portfolio has generated the same returns). Only two other years have outpaced these 2019 returns. These occurred in 1995 and 1997, posting returns of 34.1% and 31.0%, respectively. 2019 was a unique year on multiple fronts, most notably because the market returns outpaced even the most bullish forecast by any Wall Street analyst. The markets roared higher in the face of impeachment proceedings, U.S.-China trade war, Federal Reserve actions, inverted yield curve and slowing economies abroad. Furthermore, for the first time in history, the U.S. economy has started and ended a decade without a recession with the economy expanding for a record 126 consecutive months (Figure 1).

Options-Based Portfolio
Figure 1 – S&P 500, Nasdaq, and Dow Jones all set all-time highs as 2019 came to a close. The markets are in rarified territory with stretched valuations absent of any volatility. The Santa Claus rally capped off a euphoric market, generating the best returns in over 20 years

A data-driven, options-based portfolio is a method of selling options and collecting premium income in a high-probability manner to generate consistent income for steady portfolio appreciation. This strategy mitigates risk and circumvents drastic market moves and is done without predicting which way the markets will move. Options are a great way to generate superior returns with less volatility in both bear and bull market conditions over the long-term. Despite my 2019 performance lagging the S&P 500, when factoring in the Q4 2018 market sell-off, the options based strategy has generated the same returns. As 2019 comes to a close, my options-based portfolio returned ~19% relative to the S&P 500 return of 29.5%. Despite the epic 2019 market, when including the market sell-off of Q4 2018, my options based portfolio has returned 11.6% relative to the S&P 500 return of 11.2%. I was able to achieve the same market performance over the past 15 months with my current cash position at ~50% of my portfolio. Continue reading "Options-Based Portfolio: 50% Cash and Matching S&P 500 Returns"