The downturn in tech stocks this week highlights a big question on Wall Street: What's the best way to invest in artificial intelligence?
For true believers and skeptics alike, it's hard to beat the benefits of using options to create attractive payouts while defining risk.
Rather than buying AI stocks, investors can create "synthetic stock" that risks less money while maximizing gains.
Dealers and other institutional investors are using the options trading action on Space Exploration Technologies' recent stock offering to map out how to play other hot AI IPOs, including those of OpenAI and Anthropic, expected later this year, while also using those insights to trade the broader AI theme.
SpaceX's IPO was oversubscribed, and its options quickly became among the market's most active.
When options listed two days after the IPO, implied volatility was about 30% to 40% higher than where it ultimately settled. This suggests volatility-selling strategies -- using cash-secured put options, call option spreads, risk reversals, and collars -- will be good early trades.
Initially, SpaceX options trading pattern was dominated by buyers positioning for a stock rally. The shares have since wavered, falling 16% on Monday alone, and options sellers are helping to create a two-way flow, which characterizes healthy markets. Big stock owners are hedging with collared positions -- selling upside calls to buy downside puts.
As SpaceX's trading pattern takes shape, three ways seem best for anyone who wants to use options to control the stock or who is thinking ahead to other hot deals. Because we are creating synthetic stock -- trader jargon for using options to mimic actual shares -- let's use expirations of six months and longer to simulate equity ownership.
To roll back time and effectively buy SpaceX at the $135 IPO price, sell June $135 puts that expire in 2028. When the stock was at $176, the puts traded for about $35. If the stock remains above $135, the premium can be kept. June $135 puts that expire in 2027 are trading around $24. The put sales could be free money -- or not.
To harness potential upward momentum, a modified risk reversal is also worth considering. Rather than selling one put to buy a call with a higher strike but the same expiration -- the classic risk-reversal move -- consider selling two puts to raise enough money to control the stock for free. This should appeal to institutional investors who like options strategies that don't cost money.
With the stock at $156.11, sell two January $145 puts for a total of $56 and buy a January $165 call for about $34.50 The strategy pays investors to buy the stock at $145, and lets them profit from rallies. If the stock is $200 at expiration, the call is worth $35, and the puts are worthless.
Finally, consider call spreads instead of buying a stock that has yet to settle into a predictable trading range. With the stock at $156.11, buy the June $165 call and sell the June $230 call for a total cost of about $20.70. If the stock is at $230 at expiration, the maximum profit is $44.30.
A thousand Cassandras are making scary points, but AI is reshaping society. At its essence, AI sees patterns that defy human comprehension -- and that of most other technologies -- to quickly create powerful synthesized knowledge.
AI is volatile. It is the nature of investors to argue about valuations and implementation rates, and that creates market volatility. Investors can either use volatility to their advantage or be bullied by it. The better choice seems clear.
