Planning for lower risk returns

I am a bit spooked about where markets will go the end of the quarter.  Powell was understandably nervous about the economy in his speech on Wednesday – and he even the federal reserve even made its first token purchase of corporate bonds, totaling $305 million so far.

As it stands, the S&P 500 is flat YOY and down about 18% from its all-time highs.  The Russell 2000 is down 21% YOY and down 33% from its all-time highs.  This comes in stark contrast to the economic data following the worldwide economic shutdown which is still largely in effect.

There is the possibility that there will be funding shortfalls near the end of the quarter (in June), causing markets to fall – so you don’t want too much exposure on the long side.  There is also the possibility that the federal reserve decides to buy like crazy to try to keep the rally going – so you don’t want too much exposure on the short side.

My favorite plays have been gold miners – which I was significantly long using long-dated call options.  As of Friday I sold of everything in that space … now I’m at 75% cash and the rest is divided between high dividend payers with in-the-money covered calls sold on them, and January puts in IWM (the Russell 2000).

I still like the gold miners long-term, but look at this chart:

GDX 5-16-2020

If we’re coming into a potential liquidity event, there is no question this will pull back.  There is no question about the bullish backdrop here … expenses (such as fuel for heavy mining vehicles and industrial chemicals) are way down while gold remains a powerful safe haven in a time of economic uncertainty combined with heavy responses from central banks.  I don’t want to chase this right now, but I did get an idea…

I looked at some of the big mining players – FNV, GOLD, NEM, and the GDX gold mining ETF – and divided the cost of an at-the-money June 19 call over the closing price, and you get roughtly between 5-6%.  Basically, you capture a 5-6% gain over a 1-month period if the price stays flat to higher, and you’ll at least break even in a 5-6% pullback.

You could go one notch more into safety and sell an in-the-money call … with GOLD you’ve got a closing price of $28.04 and a $27 call which sold at $2.25.  If you made this trade, you’d get a gain of ($27+$2.25)/$28.04 = 4.3% in 1 month, even if the stock pulled back 28.04/27-1 = 3.85%.  Your break-even would be if the stock went down ($28.04-$2.25)/$28.04-1 = 9.2%.

I have to admit this is a very tempting way for me to play out the next month.  In doing this, it is important to purchase in small increments and try to sell your covered calls fairly quickly.  Options see a lot less trading than the underlying stocks, giving a fairly high bid/ask spread – and you will get significantly less money if you jump straight to the bid price and chase it down with sales.

Why sell the covered calls fairly quickly?  Look at this trade I made just a few weeks back:

MO end of april

To end on a positive note, I did make good money on those long calls for gold miners and SLV that I recently closed out.  I’m heading out to get some sun.  Good luck with your trading strategies.


About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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1 Response to Planning for lower risk returns

  1. Pingback: My trading scorecard: decisions traced through the pandemic | Market Thoughts – What I’m doing and why

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