Fear Has Overtaken This Market. How to Use It to Turn a Profit. - Barron's

Fear is your friend.

We have profitably made this point many times over the years, and we reiterate it again during a time when many investors are afraid that global economic growth will be slowed by the coronavirus.

In anticipation, the stock market has experienced some of its most dramatic losses in two years. One measure of investor fear, the Cboe Volatility Index, or VIX, has surged, too, and fears of lower lows in stocks have spread into the options market too.

A lot of information is floating around, and not much of it is good. Banks are organizing client calls with medical experts to discuss the virus and what could happen next. No one seems to have a good answer, and this uncertainty is reflected in the incredible push into what is considered the safest investment in the world—U.S. government debt. The profound rotation away from risk assets into Treasury bonds earlier this week into government debt and away from stocks should be considered as a warning shot across the equity market’s bow.

Investors can monetize all of this fear by selling downside put options on blue-chip stocks that they can hold for at least a few years. (Puts increase in value when the underlying security price declines.) Still, there’s another trade worth considering—one that is still under the radar but will soon likely become a major focus.

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Early next week, the Institute for Supply Management will release its February report on U.S. economic activity, and similar reports will be released that measure economic activity all over the world. These are typically used by portfolio managers as a quick way to assess the economy. They don’t make snap investment decisions based on the reports, though traders—humans and computer—will trade the event. Instead, the data often sparks further scrutiny and number-crunching that could ultimately lead investors to adjust their portfolio allocations.

It is hard to imagine that the February ISM data—which measures purchasing manager activity across a broad swath of the economy—won’t be gloomy, or be interpreted that way. This suggests it is likely to become a tradable event that is not widely focused upon because it is overshadowed by the coronavirus and U.S. political news.

If the ISM report is bad—a reading of less than 50% signals a contraction—the stock market should tumble. The January reading was 50.9%, up from 47.6% in December. (At that time, the market held steady because rates were low and nothing seemed as if it would impede economic growth.)

To position, investors could buy the March $310 put that expires March 4 on the SPDR S&P 500 exchange-traded fund (ticker: SPY) and sell the March $300 put that expires March 4. The spread cost $2.29 when the ETF was around $313. If it is trading at $300 at expiration, investors will realize a maximum profit of $7.71.

Should the market rally higher, and the ETF is above $310 at expiration, the money spent on this “put spread” is lost. Still, it is hard to see the virus issues abating by week’s end, and all economic data, especially the closely watched economic reports, are likely to be more important than ever.

If you like this trade, be prepared to act fast: The ISM report is expected to be released 30 minutes after the stock market opens on Monday.

If the idea of wagering on the broad market isn’t to your liking, there is much to be said for buying quality stocks at a time when everyone else is selling. Might such actions prove premature, with so much unknown about the virus? Absolutely. If you are willing to “buy fear,” do it in phases so you can try to optimize prices.

We have previously recommended KKR (KKR), as investors are too negative on the company’s future. Alibaba Group Holding (BABA) remains a favorite way to monetize the rise of China’s middle class, which is inevitable despite the Wuhan virus.

Corrections & Amplifications

To position for a drop in the stock market on Monday, investors could buy the March $310 put that expires March 4 on the SPDR S&P 500 ETF and sell the March $300 put that expires March 4. An earlier version of this column incorrectly said that investors could sell the March $310 put and buy the March $300 put.

Email: editors@barrons.com

2020-02-27 14:05:00Z
https://www.barrons.com/articles/fear-has-overtaken-this-market-how-to-use-it-to-turn-a-profit-51582806601