Business Are Stocks a Good Buy Now – or Goodbye?

Are Stocks a Good Buy Now – or Goodbye?

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Three things to consider when considering bullish or bearish on the SPY.

Stocks continue to rise on earnings that have so far beat expectations (albeit lower expectations). The NASDAQ 100 just closed at its highest level since last August. The S&P 500 (SPY) is on the brink of a breakout above $4200. The VIX just closed below 16 for the first time in more than a year.

Whether stock markets tear even higher remains to be seen. Momentum can certainly push prices above reasonable levels and to extremes.

To quote Keynes, “Markets can remain irrational longer than investors can remain solvent”. In the short term, markets can and will do almost anything.

Over a somewhat longer term horizon, however, three things are worth considering before considering long stocks at these levels. Let’s look back to about a year ago (11 months) when the S&P 500 was at a similar price to see what has changed over that period.

implied volatility

The two option mounts below show option prices as of Friday’s close and as of June 2, 2022 close.

Back on June 2, 2002, the SPY closed at $417.39. On Friday it ended at $415.93, so pretty much the same price as Friday, now just a bit lower (0.35%).

The options of 16 June 2023 have a term of 49 days (DTE). The July 15, 2022 options have 43 DTE. So now a little longer (6 days) for the 2023 options.

Normally, puts closer to the money with more time to expiration are more expensive. But because the VIX – or implied volatility (IV) – is low, the puts are actually much cheaper now ($6.71 now versus $11.26 then).

All because of the big drop in IV from 24.49 to 15.54. The table below contains the equation, along with a % of strike price (option price / $412 strike price) and downward breakeven ($412 strike price – option price).

So much lower costs for much better protection. Something like paying less insurance premium for a lower deductible with exactly the same coverage.

Interest rates

The 10-year Treasury yield was 2.913% on June 2, 2022. It closed at 3.452% on Friday.

The Fed Funds rate was below 1% at the time and is now approaching 5%.

No doubt interest rates have risen sharply over the past 11 months.

valuations

P/E was 21.51 on June 2, 2022. P/E today is 24.14, approaching the richest multiple since December 2021. The last time it was above 24 was on February 2 this year, which coincided with a significant top in the S&P 500.

FactSet mentioned that it’s interesting to note that Amazon.com is also the largest contributor to earnings growth for the entire S&P 500 for Q1 and 2023. Excluding this company, the (mixed) earnings decline for the S&P would 500 for Q1 2023 rise from -3.7% to -5.1%, while the estimated earnings growth rate for the S&P 500 for CY 2023 would fall from 1.2% to 0.2%. Either way, revenues are still declining and it doesn’t look like there’s going to be much growth in the coming quarters.

Higher interest rates and lower earnings should lead to lower valuation multiples and lower stock prices. Instead, equity markets are approaching new multi-year highs in valuation and all-time highs in price.

Believing in the Fed to cut rates earlier than expected and improve earnings faster than expected requires quite a leap of faith.

Traders and investors alike may want to hedge that belief a bit. It makes a lot of sense to buy downside protection with puts that are the cheapest in a long time – all things considered.

POWR options

What to do now?

If you’re looking for the best options trading for the current market, check out our latest presentation How to trade options with the POWR ratings. Here we show you how to consistently find the best option trades while minimizing risk.

If that appeals to you and you want to learn more about this powerful new options strategy, click below to access this current investment presentation now:

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All the best!

Tim Biggam

Editor, POWR Options Newsletter


SPY shares closed Friday at $415.93, up $3.52 (+0.85%). Year-to-date, SPY has gained 9.17%, versus a percentage increase of the benchmark S&P 500 index over the same period.


About the author: Tim Biggam

Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live”. His main passion is to make the complex world of options more understandable and therefore more useful for the everyday trader. Tim is the editor of the POWR options newsletter. Learn more about Tim’s background, along with links to his most recent articles.

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