Options Trading And The New Normal
As we approach the end of the year, we can start to piece together what kind of year it’s been for US stocks. There are basically two different stories to tell in 2015. There was the August correction and subsequent rebound. And, there’s been a whole bunch of range-bound trading.
The result so far is the S&P 500 is up about 3% on the year. Realistically, we’re looking at a year-end gain of somewhere between flat and 5%. That’s nothing to write home about… although it’s certainly better than losing money.
Here’s the thing…
Some analysts are calling these minimal returns on stocks the ‘new normal’. They believe this is what we can expect from stocks for the foreseeable future.
Let’s take a closer look at why lower equity returns may be the new normal and how we can profit from this environment.
So where does options trading come in with the new normal?
I’ll get back to that in a minute. First, take a look at this chart of the S&P 500 $SPX.
The chart of the S&P 500 shows exactly what I was talking about earlier. The index has mostly been trading in a fairly consistent range. Of course, we had the big August selloff with the roughly two month recovery. But, it looks like we’re right back to the range from earlier in the year.
So why may this be the new normal for stocks?
There are several reasons for this, but let’s focus on just a few of them. First and foremost, we’re likely entering a period of rising interest rates. The pace of the rate increases may be slow, but the Fed has made it clear it wants to start increasing rates. That will provide a headwind to most industries.
Second, while the US economy is doing okay, the rest of the world is still pretty much struggling. As long as international demand is stagnating, there’s only so much the US and its companies can grow.
Finally, the US economy itself is still a mixed bag. While the economy has certainly improved, there are still some sectors that are lagging well behind. For instance, US manufacturing is still a mess.
All these variables mean it isn’t likely we’re going to see a major bull market for stocks anytime soon. On the other hand, there’s no reason to believe a recession is around the corner either.
So what are the benefits to using options in this scenario?
There may be no better scenario to succeed with options than this type of environment. Options can seriously enhance portfolio returns when stocks are trading sideways. For instance, this is likely an ideal time for using covered calls.
Keep in mind, a covered call trade is selling a call against a long stock position. The trade is maximized if the stock price is right at the short call strike upon expiration. For a refresher on covered calls basics, follow the link.
Not only can you use a standard buy/write strategy (buying stock and selling calls against it at the same time), but you can also use an overwrite strategy. That’s when you write calls against your existing stock positions to help enhance portfolio returns.
For those of you willing to take on a bit more risk in return for higher yields, you could also consider writing naked puts. If you strongly believe a certain stock or index has a floor, it could be a great time to sell puts against long stock.
What’s more, if you don’t own the stock, you can sell puts at a level you don’t mind getting long the shares. You’ll either earn a steady yield on the position, or you’ll get long a stock you don’t mind owning anyways.
These are just a few of the more basic strategies you can use options for in the new normal environment. There are plenty more viable options strategies for those interested in delving even deeper. It just goes to show how valuable options trading can be for those who take the time to learn.
Yours in Profit,
Note: Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com. You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.
Category: Options Trading Strategies
About the Author (Author Profile)
Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.