Two tyrannical truths perpetually permeate the financial markets.
First, no matter how you analyze the admixture of bonds, stocks, options flows, and volatility, you must trade the market you have, not the one you think you have. Be bullish if the trend is bullish, and vice versa. Trends change and markets turn, and therein lies opportunity.
Second, while there are many ways to invest, successful investors tend to share at least one attribute: They don’t lose big. They have a sell discipline, which is to say a predetermined way to address their own bad decisions without hemorrhaging money like a severed artery.
Look beyond the normal vicissitudes of investing. This year has been especially unusual, as the stock market has advanced and options volatility has fallen—defying a litany of reasons why the opposite was supposed to happen. Many risk factors have proven to be opportunities to join what might be dubbed Stockapalooza, after Lollapalooza, the rock festival.
There is much to be impressed about. It is impressive that the Federal Reserve has managed to raise interest rates without tanking the economy. It is impressive stock indexes have advanced as much as they have. It is impressive that corporate earnings have proven to be resilient. It is impressive that war between Ukraine and Russia has been discounted as largely a nonevent.
History, which suggests that moments such as these more often invite humiliation and not bull markets, hasn’t yet repeated, and maybe won’t.
But as equities keep advancing and stock prices seem poised to be freed from the gravitational pull of enduring facts like earnings multiples, I think of a conversation I had before the 2008-09 financial crisis.
One afternoon, in the private office of the head of one of the world’s major banks, the discussion turned to why history always seemed to repeat itself in markets even though the nature of markets seemed immutable. The bank chief didn’t pause, not even for a second, before answering.
He said market history repeats because most investors lack memory or perspective. He waved his hand toward his legion of traders and strategists. Most of them, he said, were young, often in their 30s, and lacked any perspective beyond trying to make money as quickly as possible. If they succeeded, they joined, or started, hedge funds. If they failed, he fired them. Within months, the worst financial crisis since 1929 decimated markets and the economy.
I share this story as a reminder that the market might not always be as it appears, not that a great crisis is percolating.
The market is always right on price, but it has a horrible sense of timing. Here are the practical applications of this past week’s moves as earnings season accelerates:
If you sell call options on stocks to generate income, as many do, you don’t have to cover the entire position. You need dry powder, or uncovered shares, to manage the covered-call strategy should the stock surge above the call strike price and you’re forced to sell your shares.
If you cover the entire stock position and the stock then surges, consider selling stock to secure profits instead of rolling over the contract to try to make even more money. You can sell re-establish the position by selling cash-secured put options to buy the stock on a pullback.
Risk is often invisible and always omnipresent. Falling stock prices scare most investors, but they announce market sales.
Stay paranoid, and be ready to monetize chaos just in case history and high interest rates combine to roil these halcyon summer days.
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.
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