There is something wrong with the psychology of investors when a company that kids use to write and send brief messages has the power to broadly influence the trajectory of the stock, futures, andoptions markets.
Yet Snap's warning on late Mondaythat investors should expect lower growth from the social-media company has gutted what many investors hoped was the start of the end of weeks of poor market performance.
Now we find ourselves thrust back into the negative narratives that haunt the market, including rising rates and recessions. It’s almost as if Jamie Dimon of JPMorgan Chase had never madepositive statementsabout net interest income, margins, and the state of the consumer at Monday’s investor meeting, which sent markets jumping.
Of course, there is much to fret about as the Federal Reserve and other central banks abandon decades of easy-money policies that drove stock prices ever higher. But we must remember some key facts: Dividends account for about 40% of historical stock returns. Inflation adds another few percentage points. Success in the markets is thus greatly influenced by owning quality stocks and staying the course even when every fiber of your being suggests otherwise.
Fortunately, investors armed with some basic knowledge can use options to help smooth out the stock market’s gyrations. In recent weeks, we have focused onselling covered call options—or selling calls on stocks you own—to offset declines and to generate added income. This week, we’ll focus on cash-secured put sales. (Calls give owners the right to buy a specified asset during a set period, while puts give owners the right to sell a specified asset during a set period.)
Many investors are interested in buying quality stocks at lower prices, and this strategy gets the options market to pay them for agreeing to do so. In order to play, investors must have the cash needed to buy the stock at a lower price. (That money is deposited in a cash-management account and held by a broker.)
Consider theFinancial Select Sector SPDR exchange-traded fund (XLF), which comprises many of the world’s finest banks. In a rising-rate environment, such companies should thrive, provided the economy doesn’t spiral into a recession. The investment thesis is simple: People will always need money, and hence banks.
With the ETF at $34.21, investors could sell the July $32 put for about 80 cents. If the ETF remains above the put strike, investors can keep the options premium. Should the stock price fall below the put strike at expiration, investors are obligated to buy the ETF, or to roll the put to more distant expiration dates to avoid assignment.
The risk is that the stock falls far below the put strike price. Only use this strategy if you are willing to buy the stock and warehouse it for three to five years.
During the past 52 weeks, the Financial Select Sector SPDR ETF has ranged from $32.23 to $41.70. It is down 15% this year.
To be sure, people never tire of reading about others who mismanage their financial affairs, or who go wild withthe latest investment craze. It makes them feel better about themselves—and it is more exciting than reading about prosaic ways to effectively handle financial matters.
But know this: The conservative use of options can be used to generate meaningful conditional dividends. Of course, there are risks, but the risks are defined. The catch? You must be willing to buy low and sell high.
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