This Options-Backed Strategy Can Help You Dodge the Stock Market’s Hazards

There are certain financial facts made truer by time. Never let transitory market drama make you forget that.

Compound interest, which some have called the eighth wonder of the world, helps portfolios to exponentially increase in value. Dividends, which account for about 40% of historical stock returns, are a humble miracle worker that injects some certainty into an uncertain process.

When compounding and dividends are combined and enhanced with conservative options strategies, investors harness some of the most powerful financial forces in the world.

Yet many investors are distracted from these time-tested facts by issues that are beyond their control.

Hardly a day passes without some strategist, pundit, investor, or central banker opining about when the Federal Reserve might lower interest rates, or if inflation is dissipating or increasing. Other known unknowns range from concerns that wars in the Middle East and Eastern Europe will spark World War III to the deep political divisions back home.

All of this is interesting to debate, though difficult for most to use when analyzing investments. Rather than embracing paralysis by analysis, it’s better to remember that time, volatility, and markets are forever. We recommend what we call a “time arbitrage” strategy designed to take advantage of short-term market volatility for the benefit of long-term investments.

It consists of embracing dividends, compounding, and options-selling strategies —and applying them to strong, investible themes.

The approach works on just about any blue-chip stock that has an investible rationale—even if it doesn’t pay a dividend—and that can be held for a minimum of three to five years and ideally longer.

Some great themes to consider include weight-loss drugs; the artificial-intelligence ecosystem, including chips and data centers; the privatization of finance; the rise of streaming media; electric vehicles; and demands on the power grid. Pick the ones that resonate the most with you and research the many companies that are involved to find the ones that are best positioned, or most intriguing.

Consider Eli Lilly LLY -2.64%, which just reported solid earnings —helped by weight-loss drugs Zepbound and Mounjaro—and enhanced financial guidance.

With the Big Pharma stock at $781.10, investors could sell the June $740 put option for about $14.50. The put sale obligates the seller to buy shares at an effective price of $725.50 if the stock is below the put strike price at expiration. Should the stock price exceed the put strike, sellers can keep the premium, which represents a 2% return on the cash-secured put premium. (To determine the investment return on cash-secured put sales, divide the options premium by the strike price premium and multiply by 100.)Bond yields have recently been racing higher. If the 10-year Treasury yields 5% or more, it would likely pressure stocks, as such a high return might prompt some investors to rotate from stocks to the relative safety of bonds. This would likely increase options’ implied volatility for a few weeks to a few months—benefiting investors who sell options.

Long-term investors should welcome any short-term stock weakness because it will reset valuations to more attractive levels.The time-arbitrage approach monetizes some of the uncertainty that is always present in markets, while helping investors discipline their emotions and inject discipline into their decision-making. Such modest tweaks—coupled with the aforementioned financial facts made truer by time—can work wonders.

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Originally Posted May 1, 2024 – This Options-Backed Strategy Can Help You Dodge the Stock Market’s Hazards