For the first time in years, it’s possible to buy loads of stocks that are not dancing around record high prices. Unfortunately, the reason why prices are suddenly so low is because no one has any idea what may happen next with the coronavirus that is terrifying the world.
If the coronavirus becomes a global pandemic that lowers economic growth and thus corporate earnings, stock prices will fall even lower. If these fears ultimately prove unfounded because the virus is contained, stock prices will naturally advance. Timing is everything.
To monetize those simple facts, intrigued investors can dip their toes in the stock market via the options. For a fraction of the cost of buying stock, investors can buy bullish call options that will increase in value if stock prices rise. Buying puts, which increase in value when stock prices decline, is simply too expensive at a time of widespread fear. The time for hedging was when no one was afraid, as we suggested a few times since late November when the biggest fear in the market was if Bernie Sanders would challenge Donald Trump in the presidential election.
Now, everyone is afraid of the virus and the financial sector might be ground zero. If the global economy falls into a recession, or central banks once more lower interest rates, big banks will likely struggle. Already, the stock prices of top banks have been decimated in anticipation.
In mid-January, Goldman Sachs (GS), for example, was trading around $250. The stock has since dropped to about $200, dragged lower by concerns ranging from the coronavirus to an international economic slowdown. So far this year, the stock is down about 13%, and it is only up 1.3% over the past year.
While we frequently advise investors to sell downside puts on blue-chip stocks like Goldman Sachs, we are going to instead focus on bullish calls. The switch reflects a hunch and desire to position for stocks to rebound in six months or more without committing loads of money to the actual outcome. After all, there is no way to know if stocks rally higher from here, or if they will drop even lower. Similarly, it is hard to know if investors are over reacting, or not, to the virus.
If this type of aggressive speculation appeals to you, consider buying Goldman’s October $210 calls for $16.16 when the stock was around $200. The expiration was chosen to provide plenty of time for the virus fears to abate, or for governments to find ways to remedy any economic slowing.
Every call covers 100 shares of stock but at a much lower cost than buying stock. If the stock is at $260 at expiration, the calls are worth $50. If the stock is below the strike price at expiration, this trade fails, and it likely that stocks everywhere have fallen even lower to the widening of the coronavirus. During the past 52 weeks, Goldman’s stock has ranged from $180.73 to $250.46.
You can consider this call trade structure for any stock that you think could rally higher should virus fears abate. Unlike buying stock, the call defines the risk to the amount of money paid for the option, which will be a pleasing fact if the stock declines. Simply put, you will lose less money buying calls than stocks.
To be sure, we could frame this suggested approach with persuasive data and insights from strategists and pundits that buying calls when everyone wants to buy puts is a reasonably surefire way to make money. But the fact is that there is no way to know how what happens next, and so the strategy should be considered as nothing more than an abiding belief that investors are generally too bearish, or too bullish, and that options help investors define risk and reward, especially if the timing is right.
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