Extreme Volatility: Options-Based Portfolio Approach

Cash is a critical component to any portfolio strategy to reduce volatility, seize opportunities, lower cost basis of a long position and avoid full exposure to the equity markets. Controlling portfolio volatility is essential as the broader markets continue to undergo a sea change from high beta/richly valued technology stocks and into value names. The past four-month stretch from September 2021 - January 2022 serves as a prime example of extreme market volatility. The markets pushed to new all-time highs early in September 2021, then suffered a significant selloff in the same month where the Dow Jones was down as much as 6%. October 2021 saw a bounce back into positive territory with new all-time highs set. Then the November/December 2021 stretch saw a sharp dichotomy between the tech-heavy Nasdaq and the Dow Jones, with these indices experiencing relentless selling and heavy buying, respectively.

Amid the bifurcated market, entire sectors have been decimated, and some companies have lost swaths of market capitalizations. Even many well-established, profitable large-cap companies have seen their market capitalizations reduced in a meaningful way. Entire sectors of the market have been wiped out, specifically the fintech space and some pure stay-at-home plays. Given the market backdrop, the cash portion of the portfolio can come in handy to seize unique opportunities to bolster a portfolio. In addition to cash, a conservative options strategy can offer additional mitigation against these pockets of extreme volatility.

A Holistic Approach

Proper portfolio construction and optimal risk management is essential when engaging in options trading to drive portfolio results (Figure 1). Managing a long-term successful options-based portfolio requires a risk tolerance balance between cash, long equity, and options. Ideally, an options-based portfolio should be broken out into the below structure (This is an example breakdown, and percentages can be modified): Continue reading "Extreme Volatility: Options-Based Portfolio Approach"

Apparently, Valuations Do Matter

2021 ended with a bang, with the S&P posting a 27% gain on the year. This appreciation occurred with the markets were facing a trifecta of rising interest rates, an unknown coronavirus variant backdrop, and the Federal Reserve tapering. The major indices reached unprecedented territory breaking through all-time high after all-time in what seemed like a daily occurrence throughout the year until the back third of the year rolled around. The September correction was a harbinger that valuations do matter, albeit October saw a huge reversal to the upside. Then came the November/December bifurcation in the markets, along with extreme bouts of volatility. Despite the back third of the year, the S&P 500 posted a 27% gain, placing the index in rarified air across many valuation metrics.

As interest rates, fed taper, and the pandemic gripped the markets, a sea change occurred. This sea change started to take hold back in November and December of 2021 while really accelerating in the first week of January 2022. As a result, technology names experienced heavy selling, specifically in stocks with high beta and/or rich valuations. This massive rotation came out of technology companies that are unprofitable with proof of concepts and into value-oriented companies that are well-capitalized, profitable, and pay dividends. As 2022 continues onward, this theme will lead the charge in the markets until the uncertainty surrounding the pandemic and the interest rate environment is settled out. Continue reading "Apparently, Valuations Do Matter"

Block and PayPal - Ostensibly Bottomed

Before the massive market rotation and tech-heavy selling, specifically in high beta and richly valued stocks, fintech had been in a multi-year secular growth trend. Recently, high-quality names in the space such as Block (SQ), formally Square, and PayPal (PYPL) have seen their stocks nearly cut in half. Block has come down from $298 to $138 or a 54% drop, while PayPal has come down from $310 to $179 or a 42% drop. All the rage has been about the buy-now and pay-later platforms as a disruptor to the entire payments space. However, Block came through with a $29 billion, all-stock deal to buy Afterpay, a major buy-now, and pay-later platform. Block's acquisition highlights consumers circumventing traditional credit, especially younger buyers, for installment loans. PayPal also offers their version of buy-now and pay-later offering, which showed fantastic growth over the holiday season and a surge of 400% on Black Friday alone.

Both Block and PayPal are firmly in the buy-now and pay-later space while also enabling businesses at the point of sale, analytics, peer-to-peer payments via Venmo (PayPal) and Cash App (Block), small business lending, cryptocurrency transactions, and support traditional credit card integrations into their platforms. Block and PayPal offer end-to-end financial solutions for businesses and consumers while powering the next generation of financial technology. These financial technology companies are creating additional revenue verticals while addressing unmet needs in the financial services space. Both Block and PayPal may offer long-term growth at very reduced valuations due to the tech-heavy selling, when factoring in their end markets are current growth rates. Continue reading "Block and PayPal - Ostensibly Bottomed"

Disney - Irrational 52-Week Low

Disney's market capitalization had been eviscerated by over 30%, and the stock price hit an irrational 52-week low in early December. Disney's valuation has been in a tug of war between its legacy business model and its streaming initiatives. Disney should be in the sweet spot of capitalizing on the pent-up post-pandemic consumer wave of travel and spending at its parks while being the new and preferred stay-at-home content provider via Disney+. However, the former has been altered due to uncertainty over the newest omicron coronavirus variant while the latter continues to build out content and expand its membership base.

Disney (DIS) has rolled out a wildly successful array of streaming initiatives that catered to the stay-at-home economy during the pandemic. These streaming efforts have transformed Disney's business model, which its legacy businesses will further bolster as the world economy prospects continue to improve and reopen, albeit minor bumps in the road.

Taken together, Disney has set itself up to benefit across the board with its streaming initiatives firing on all cylinders and theme parks coming back online. The company has been posting phenomenal streaming numbers that have negated the negative pandemic impact on its theme parks. This streaming-specific narrative will change as the theme park revenue comes back online and flows into the company's earnings. As a result, Disney presents a very compelling buy for long-term investors as the synergy of its legacy business segments get back online in conjunction with its wildly successful streaming initiatives, all of which have more pricing power down the road to expand margins. Continue reading "Disney - Irrational 52-Week Low"

Moderating Valuations - Deploying Capital

Recent Turbulence

Inflation, interest rate hikes, employment, Federal Reserve taper, new omicron pandemic backdrop, Washington wrangling, supply chain disruptions, and travel restrictions are culminating and resulting in the current market swoon. September saw a 4.8% market drawdown for the S&P 500, breaking a seven-month winning streak. November saw negative returns, and thus far, December is off to a bad start. Prior to the September meltdown, stocks were very overbought and at extreme valuations as measured by any historical metric. Heading into September, valuations were stretched across the board, with the major averages at all-time highs and far away above pre-pandemic highs.

The recent two-week stretch over the November/December transition was met with heavy and vicious selling. Valuations have moderated overall and cooled investor enthusiasm, especially in the more speculative momentum stocks in cloud software, SPACs, and recent IPOs. The technical conditions (RSI and Bollinger Bands) are shaping up for a strong relief bounce that may coincide with the infamous Santa Claus rally. The tremendous volume of selling has inflicted damage across the board, indicating that valuations do, in fact, matter after all. Many opportunities are presenting themselves, and being too bearish may prove ill-advised over the long term.

Vicious Selling

As of the beginning of December, a third of the S&P 500 is off at least 15% from its high, and nearly one in eight Nasdaq stocks logged a new 52-week low. Furthermore, the CNN Money Fear & Greed Index, a composite of market-based indicators that gauge risk appetite across stocks, bonds, and options, dropped to its 2021 lows, seen during previously equity pullbacks. It has only tended to plunge below this when the market is in near-crash mode, such as December 2018 and March 2020. Continue reading "Moderating Valuations - Deploying Capital"