On Monday, markets plummeted around the globe as the fears of a Grexit materialized after Greek PM Alexis Tsipras called for a referendum to decide the country's fate in the Eurozone. The apprehension regarding a Greek exit and what it might mean for other peripheral EU economies sparked a global downturn in equities, and a rally in safehaven assets such as long-dated US treasuries (NYSEARCA:TLT).
The S&P500 (NYSEARCA:SPY) registered its biggest loss for the year, effectively erasing year-to-date gains. Similarly, other blue-chip aristocrats such as Johnson & Johnson (NYSE:JNJ), Verizon (NYSE:VZ), ExxonMobil (NYSE:XOM), and many others tumbled amidst high volatility.
No Real Impact On Earnings
In essence, the outcome of the Greek crisis will likely have no impact on the fundamentals of these strong businesses that possess a wide moat. The earnings and growth potential of these quality businesses will not been affected in the slightest; the across the board drop in share price reflects irrational fear and greater uncertainty instead of any real macro risks to these businesses. Granted, Greece's potential exit from the Eurozone is a major world event, but the fallout, if any, will be confined to lower paper asset prices and would hardly have an effect on the "real economy".
At worst, Greece's exit and default could affect the balance sheet of European governments. Given that Greece owes very little debt to the private sector, and that its GDP is measly compared to bigger European peers, it has no tangible effect on the health of the US or EU economy. Crucially, this is a political problem and a question of confidence, not an issue of macro fundamentals.
Hence, this is a rare chance for investors to establish long positions at lower valuations. In the coming week, we may see equity prices take a continued slide as uncertainty grows over the outcome of the Greek referendum, and the implications for the Eurozone as a whole. This is also likely to drive up the price of safehaven assets and volatility.
The best way to take advantage of this situation is not to buy shares outright - it is to sell puts on shares that investors wish to accumulate.
Selling Puts Is The Optimal Strategy
Due to the magnitude of the fall Monday, volatility has shot up across the board, leading to higher premiums for share options.
Investors who wish to accumulate shares should sell put options with a short maturity and a strike price close to the current share price, with the intention of being exercised upon expiry. This allows one to build a long position at slightly lower prices, and boosts returns with the premiums collected on selling puts. Investors could also sell puts with different strikes to hedge against the risk of a sharp decline, but must be prepared to take assignment upon expiration.
Another strategy would be to sell SPY puts with a long maturity, taking advantage of the temporary spike in volatility which has resulted in higher premiums. Excluding the Greek crisis, the S&P has traded in a fairly tight and narrow range this year, reflecting low implied volatility and hence low option premiums. When the Greek crisis blows over and begins to de-escalate, be it with the decision to leave or stay in the Eurozone, S&P volatility is likely to return to lower levels, leading to lower option premiums. This would allow investors to buy back the same options and close out the trade at a substantial profit.
Alternatively, if one is ready to hold these puts till expiration, they should do so by selling at a strike further away from the current price. This ensures a higher return on capital, but such a position would require more commitment in terms of capital and managing the position.
Selling long-dated puts on the S&P 500 and other companies such as Coca-Cola (NYSE:KO) is a strategy that has been used by Warren Buffett to great effect. For anyone planning to execute this strategy, I highly recommend reading his annual report to shareholders, where he details the deficiencies of option pricing as well as the advantages it offers investors.
Investors should take advantage of the spike in volatility and slide in equity prices to accumulate positions on blue-chip stocks with a wide-moat and competitive advantage. Additionally, selling puts on high-quality companies or the S&P could boost returns when volatility normalizes.
Disclosure: I am/we are long SPY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.