Why Some Traders Are Betting on a Sharp Decline in Stocks

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A trader on the New York Stock Exchange on December 20.

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Spencer Platt / Getty Images

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When in doubt, get out.

The Old Jigsaw expresses a view that investors should stay on the sidelines when they have doubts about what is happening in the stock market.

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The axiom is being relaxed at the end of 2021 as markets hit record highs, discounting the impact of another Covid boom and plans to end the Federal Reserve’s easy-money policies that have long the economy, and thus the economic market.

Traders are getting deep into the market instead of exiting. To do this, they are using options, which have emerged during the pandemic as an investment that is often more popular than stocks.

The new principle – when in doubt, sell put options that are too far – is evident throughout the market. Some investors are selling bearish puts expiring in January and February with strike prices that are well below the market price of the associated stock. Trades often place contracts of about 50 cents to $1 to investors who are willing to buy the stock at 20% to 30% less than current stock prices.

Put-sale activity is notable for the large number of contracts involved in each trade, which equates to a large share count, and for the variety of stocks.

The activity is notable because such large trading volume is rarely seen at strike prices that are far below the respective stock prices. Most investors sell puts with strike prices that are about 5% to 10% lower than stock prices.

Alison Edwards, a Susquehanna Financial Group strategist, recently advised clients that they have seen far-reaching selloffs over the past two weeks in a motivating group of stocks with mostly January closings. Trading took place in APA (ticker: APA), Bloom Energy (BE), Doximity (DOCS), Pagseguro Digital (PAGS), Match Group (MTCH), Plug Power (PLUG), and Sunrun (RUN).

A broad pattern of action includes selling of the 6,000 DoorDash (DASH) January $110 Put, the 6,000 DataDog (DDOG) January $140 Put and the 12,000 Lucid Group (LCID) February $25 Put.

It is always difficult to analyze someone else’s trade, but put sales are driven by a simple desire to own shares at low prices. Instead of doing nothing and waiting for the market to weaken, these investors have found a way to get a return on their money.

This type of trading has long been a favorite of wealthy investors, who regularly sell such puts on the S&P 500 index as a sophisticated cash-management strategy. If the stock continues to move up, investors retain the money received for selling the put. If they are forced to buy the stock, they do so at a dramatically lower level.

We have long supported the cash-secured put sell trade, and still do. However, consider a possible twist to the general approach: Wait to sell the put until the market declines sharply and a fear premium downside pushes the put’s value further up.

Should this be the case when investors return from the holidays, long-term investors may actually consider selling blue-chip stocks in the midst of a market turmoil to extract a major risk premium. The put premium should increase when the stock prices fall.

This strategy is no doubt as boring as it is effective, but it provides a nice respite at a time when the world is once again surrounded by so much drama.

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.

E-mail: [email protected]

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