The market's wild gyrations continue. As the week draws to a close, it seems like there is some possibility that the fast money will take some of their capital off the table for the weekend and the market will be weak on Friday. If that happens, an individual investor needs to think about their actions. Should they also be taking money off the table, doing nothing, or buying? Buying into any Friday weakness could be “catching a falling knife” or it could be “buying when others are fearful.” Hard to say which it is, but it certainly seems like the market is cheaper than it was a month ago. Hence, the CCI is inclined to put some of its dry powder to work on any weakness. In addition, high volatility in options means there might be an opportunity to effectively use options to provide some hedging, income generation and/or leverage to these positions.
If an investor is inclined to buy into any potential Friday weakness they should be putting their shopping list together in advance. Below is my Friday ETF shopping list. It provides a lot of equity diversification with only three positions. It also uses options in the immediate, short and, mid-term time frames to allow different time frames for market moves.
Utilities ETF (XLU) – mid term, covered call strategy.
Despite their defensive nature and interest rate sensitivity, utility stocks have sold off pretty much in lock step with the market. This has lowered valuations and raised dividend yields on almost all stocks in the sector. Option volatility on the XLU ETF has also increased in conjunction with increased market volatility. I'd look to buy the ETF and sell the January at the money call against it on any weakness. At the time of this writing, XLU was trading around $31.60 and the Jan. $32 call options was trading around $1.30. There are also likely two dividend payments between now and January totaling about $.65. That results in nearly $2.00 (6+%) in income between now and January if the etf just stays near its current levels. The stock has to fall below $30 to lose money.
Materials ETF (XLB) short-term risk reversal
Materials stocks have been some of the most punished stocks in the market, mostly on the belief that a potentially slower economy means less demand for these products. That may or may not be true, but it also seems true that one of the major input costs (energy) for these companies are falling. Also, in the longer term it seems like a growing world population will continue to drive demand for these products.
I'll be looking at establishing a risk reversal options strategy on this etf. For example at the time of this writing the XLB was trading at around $34. The Dec. $32 puts cold be sold and the Dec $35 calls could be bought for a small amount of out of pocket cash. This commits an investor to buy the Etf at $32 (down about 6%) and gives the investor all the upside over $35 (up about 3%). This favorable risk/reward seems like a good way to play for a rebound in the materials sector.
Japan ETF (EWJ) – sell near term puts
During the tsunami the Japanese market as represented by the ETF EWJ fell to a low of $9.24. As of this writing it was trading at $9.80. I'm looking at selling the $9 Sept puts on any pullback for a modest 1-2% potential gain. The risk is that the major Japanese companies in this etf fall to below their tsunami levels. If that were to happen perhaps it would be a good long term holding anyway.
This is not to say CCI is bullish on Japan over the long term. Rather I don't see Japan's demographics, debt, and lack of natural resources as a long-term positive story. Overall CCI is underweight Japan with Asian holdings such as AAXJ, EWY, EWS . But this trade looks like that could yield 1-2% in premium yield. That is nothing spectacular (but the same yield as a 5 year US treasury) for what seems like a prudent risk.
An investor more bullish on Japan could also consider selling the $10 puts.
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Hopefully the market will have an upward trend on Friday. In that case these picks will likely be put on the shelf, and an early happy hour will be in order. However, if the market is weak Friday afternoon these may be worthwhile positions to enter.