We’re about to see how investors have loved their stocks over the past 20 years.
The start of earnings season, along with the imminent reality that the Federal Reserve will raise interest rates from historically low levels, means that many stocks that have performed well over the long run may struggle under the new realities.
To help handle what comes next, investors can consider using a simple options trading strategy to offset potentially stalling or sputtering stock prices that have performed well in the past. but could not succeed in the new market environment.
By selling bullish call options on preferred stocks that are coming under pressure as the so-called Fed put nears expiration, investors can increase the yield on their shares.
The strategy is simple. Sell calls expiring in a month or less, with the strike price approximately 10% to 15% above the stock price. If the stock price stays below the strike price, investors can place the option premium.
This covered-call strategy pays off for people being long-term investors — with one important twist: If the stock price is above the strike price at expiration, investors should either sell the stock, or buy the call back at a loss. , or any other monthly expiration date.
At this juncture, nothing needs to be done, but investors need to start thinking of new ways to handle their old stocks as the market rush prepares itself for higher interest rates.
We continue to believe that it makes sense to wait for the Fed to conclude its two-day meeting on January 26. The meeting should present important information, or confirmation of expectations, to the market.
In anticipation, investors are revaluing stocks that have a price/earnings multiplier higher than the S&P 500 index,
These so-called growth stocks are often under pressure or in decline, while cheaper-priced stocks tend to get stronger and move higher.
So far, the rotation appears to be largely attributable to institutional investors, which is the reason why the discounted cash-flow model used to value stocks means highflying technology stocks suddenly go short. .
In short, the future value of cash flows is lower if rates are higher. Almost no one outside the securities industry thinks or talks about the discounted cash-flow model, which probably means people will have hard lessons to learn after decades of reliably watching stocks.
Mini-crises are likely to emerge across millions of portfolios as investors face the end of historically low interest rates that have kept stock prices high for long periods.
Many stocks—especially high-flying technology stocks that have long led the broader market—may no longer behave as they used to. Investors will probably be reluctant to sell stocks that have performed so well, even if they manage to put money into new hot areas, including financials and cyclicals.
There is no doubt that the stock market has its ups and downs. Investors are debating what could happen after the Fed raises rates or provides more clarity. Instead of anticipating what will happen, develop a plan and be prepared to react to concrete news rather than just speculation about the future.
Some investors may not want to pay tax on unrealized gains. Others would argue that the broader markets and their preferred stocks would soon stabilize once monetary policy normalises.
Everyone can be partially right and wrong, and nothing is gained by trying to guess the outcome. Instead, if you have stocks that can get bumped around, or that have exploded in recent weeks, consider using a covered-call strategy.
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialty asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.
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