2 Stock-Option Strategies That Split the Difference Between Fear and Greed

Inertia may be the most powerful force in the universe.

If people increased their action levels by just a tenth, their lives—and especially their financial accounts—would almost certainly look a lot better.

But in a world in which bosses or work processes often make decisions for people, inertia defines most people’s actions. Such is the machinery of life.

This is especially true when it comes to investing. Inertia is an infection that harms investors’ ability to accumulate wealth. In the absence of a framework for making decisions and for managing fear and greed, it’s hard to truly progress in the markets beyond riding the bullish and bearish currents. You have to possess a decision-making framework in a chaotic environment, or else you are just a beta investor in an alpha world.

This call to action comes to mind after months of discussions with investors, many of whom are afraid to invest in equities even though the supposedly safe bond market mostly offers nonexistent returns. And, despite investors’ fears, stocks continue to dance at record highs.

Still, it remains popular among the very wealthy and the commentariat to insist that stocks are disconnected from reality. That statement sounds suave and sophisticated, but stocks are always disconnected from reality—that is, past reality. It’s the nature of the stock market to always look to the future and try to determine what something will be worth tomorrow, and not today or yesterday.

We have long advocated selling cash-secured puts on blue-chip stocks that you are willing to own for a minimum of two to three years. We also have advocated a risk-reversal strategy that entails selling a put and buying a call with a higher strike price but same expiration. Now, some institutional investors—sophisticated players who always try to use options to control stocks for as little as possible—are elevating the approach.

Chris Jacobson, a Susquehanna Financial Group strategist, recently noted that some investors are selling puts and buying call spreads on many blue-chip stocks. The strategy monetizes the ever-present fear premium that defines bearish put options, while tempering the greed premium of so many bullish call options as the market trades around record highs.

Consider Walt Disney (ticker: DIS), the entertainment conglomerate. We have recommended Disney shares twice in the past six weeks, when the stock was at $113. Lately, Disney has been trading around $130. One investor recently bought 4,000 January $140 calls and sold 4,000 January $155 calls, and also sold 4,000 January $110 puts for a small credit. The strategy allows the investor to buy shares at $110 and to profit from an advance to $155.

Similar trading occurred in Cisco System’s (CSCO) November expiration, the December expirations for Bank of America (BAC), Citigroup (C), and Colony Capital (CLNY), and the January expirations for Comcast (CMCSA), Starbucks (SBUX), and Morgan Stanley (MS).

The choice of stocks that are now harnessed by options is worth noting. Most of the companies are blue-chip stocks that have great staying power. They’re the kind of names that any investor should want to own. For investors afraid to buy stocks because they fear a correction, options offer a way to rent stocks without buying them.

Jacobson wrote that investors—or perhaps just one investor unconcerned about everyone knowing what he or she was up to—appear to be using call spreads to profit from a stock’s advance, while lowering the cost of upside positions by selling puts. The strategy, he noted, might make sense for investors who are hesitant to buy stocks that are rallying yet don’t want to miss out on gains, while at the same time are willing to buy stocks at lower prices. That’s one way to counter inertia.

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Originally Posted on August 20, 2020 – 2 Stock-Option Strategies That Split the Difference Between Fear and Greed