Every new year begins with the hope of personal growth and a commitment to a healthier lifestyle. However, amidst these individual aspirations, the stock and options markets operate in a realm immune to self-improvement notions.
The risks that plagued markets in the past year persist in 2024, with one crucial factor poised to define the new year - unless regional conflicts in the Middle East and Europe escalate into global confrontation.
And what is this defining factor? The Federal Reserve, which aggressively raised rates last year, is now anticipated to embark on rate reductions in the coming months.
This revelation is not lost on 's readers or even those with a casual interest in financial markets. With nearly a quarter-century of exceptionally favorable financial conditions, society has become accustomed to low interest rates as an entitlement.
The prolonged period of ascending stocks has seemingly turned everyone into a financial savant, even in unexpected quarters. A recent anecdote revealed the staff and residents of a homeless shelter in the Northeast animatedly discussing day-trading stocks and cryptocurrencies.
This eagerness may represent a sincere desire for improvement or serve as a forewarning, reminiscent of the legendary shoeshine boy from the 1920s who dispensed stock tips to his patrons.
To secure one's economic stability and avoid homelessness, one must adopt an attitude of cautious optimism. While markets generally ascend over time, it is crucial to question passing trends and avoid blind adherence to them, as sustained and significant returns are rarely achieved without skepticism.
The Federal-Funds Futures Curve: A Distorted Prediction?
A significant question arises for 2024 regarding the federal-funds futures curve, widely regarded for its accurate forecasting of interest rates. Presently, the curve suggests that rate cuts are expected in 2024. However, an intriguing concern emerges as we contemplate whether the investors who shape the curve have become less rational and more akin to a volatile market mob. Could investor narcissism have tainted once objective areas of the market, leading to a distorted prediction of rate cuts?
Acknowledging that it may seem unconventional for an equity-oriented investor to question the bond market, it remains challenging to comprehend why data-dependent Federal Reserve governors would so swiftly declare victory over inflation without ensuring the enduring strength of the economy. Consequently, upcoming meetings to discuss rates may bear more significance for the trajectory of the stock market and levels of options volatility than currently anticipated.
The Federal Reserve's rate-setting committee will conclude its first meeting of the year on January 31st and its second meeting on March 20th.
Investors seeking to purchase blue-chip stocks at lower prices and capitalize on potential gains may consider a "risk-reversal" trade using the SPDR S&P 500 exchange-traded fund. This strategy involves selling a put option and simultaneously buying a call option with a higher strike price but a similar expiration date. By doing so, investor fear, whether subtle or pronounced, is transformed into a monetizable asset through the capture of put premium, while still allowing for profits if the ETF experiences gains.
At the current price of $472.65 for the SPDR S&P 500 ETF, investors can sell the April $460 put option for approximately $7.67 and purchase the April $485 call option for around $9.15.
In a scenario where the ETF reaches $500 at expiration, the call option would be valued at $15. The primary risk associated with this strategy is if the ETF significantly drops below the put strike price. In such an event, investors would be obligated to purchase it at the put strike price or adjust the position to avoid assignment.
This approach aims to rein in the exuberant spirit that has defined the markets following the remarkable stock rally of 2023.