Investors fail to fully appreciate that corporate earnings are the most potent put option in existence -- even more powerful than the so-called Fed put, which has long backstopped the market.
As long as corporate earnings are growing and profit margins remain robust, stocks should be able to endure all sorts of volatility and risk.
This "earnings put" should ease concerns that Kevin Warsh, the Federal Reserve's new chairman, isn't as eager to mollycoddle investors as his predecessors were.
Many investors are rattled by Warsh, who has vowed to change the Fed. He has appointed committees to review operations and advise on issues ranging from how the Fed deals with inflation to how it uses its vast power to influence debt markets.
The uncertainty has made the Fed's late-August Jackson Hole Economic Policy Symposium a tradable event. We think markets are likely to be pleasantly surprised. We expect Warsh will use the opportunity to make himself better understood to investors accustomed to solicitous central bankers.
For investors who must be in constant motion, always wagering on the next big event, one way to bet on Jackson Hole is to buy call options on the State Street SPDR S&P 500 exchange-traded fund that expire just after the bank meeting concludes on Aug. 29.
With SPY at $770.59, buy the September $780 call that expires Sept. 11 for about $7.56. At $795, the call is worth $15. If Warsh disappoints and SPY declines, the money spent on the call is lost. Calls cost less than stock, so take solace in that.
During the past 52 weeks, the ETF has ranged from $629.28 to $776.85. It's up 13% this year.
Our trade is a simple bet that stock prices will keep rising as investors increasingly take comfort in strong corporate earnings reports.
The Cboe Volatility Index, or VIX, is around 15, below its long-term average of 19, suggesting that investors are more relaxed than is appreciated. At the current level, the VIX indicates the S&P 500 will move just under 1%, up or down, each day over the next month.
Flow data supports bullishness. Investors aggressively bought stocks and call options on the S&P 500 in early August, reversing July's risk-off stance.
Moreover, a strong odor of self-dealing is wafting through the markets after Situational Awareness' situational unawareness. The highly leveraged hedge fund, headed by Leopold Aschenbrenner, was forced to unload many of its artificial-intelligence stocks at bargain prices to meet margin calls when the tech trade ran into trouble earlier this month.
A lot of the recent weakness in the technology sector, especially among popular AI stocks, seems attributable to the hedge fund's troubles. We think news of the fund's margin woes leaked and that some big investors subsequently shorted many of its stocks, here and in South Korea.
When those investors, and others, learned that Ken Griffin's Citadel would rescue Situational Awareness, it seems investors with information on the margin calls covered their shorts and bought index calls to profit from a rebound. The demand was so intense that it set a one-day record of about four million bullish calls on the S&P 500 on Aug. 4.
We expect many of those investors will now focus on buying stocks and using an event-heavy calendar to increase the value of their bullish bets.
As many investors, retail and institutional, have learned in recent years, if enough of them act together they can mint profits by using the power of the group to trade options and then move stocks though strike prices.
The big, bullish index trades suggest more gains, just as surely as the Situational Awareness rescue removed a lot of instability from the technology sector, which is so important to the stock market's equilibrium.
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