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Buy Call Options in 2011

Use calls to leverage the climbing stock market


Some of the best-paid institutional strategists have said that the market will rise this year anywhere from 7% to 17%, with many agreeing around on an 11% increase. That suggests option trading investors should be buying call options.

Put simply – the call for 2011 is to buy call options.

The market prognosticators site a number of factors for their upside view, including – low interest rates; rising corporate profits; a low market p/e ratio; accommodative fiscal and monetary policy; 3% to 4% GDP growth; rising small business and consumer confidence; productive slack in terms of both labor and plant keeping cost-driven inflation pressures low; and a raging corporate bond market that should drive stock buybacks, LBOs, dividends, and mergers and acquisitions.

These bullish factors outweigh concerns regarding escalating trade tensions, tightening credit in emerging economies, continued European sovereign debt problems, intensifying cutbacks at the state and local government level, rising investor bullishness (generally an inverse indicator), rising interest rates, a scary-high federal deficit and debt, and potential conflicts ranging from Iran to Korea.

Here’s our call — We see the S&P 500 (SPX) heading back to its former high of about 1,550 over time. It may not get there in 2011, but we believe it’ll make significant progress toward this milestone next year. Of course, there will be ups and downs with plenty of head fakes, but the trend will be our friend — and dips should be bought.

Periods of negative rolling 10-year annualized returns for the S&P 500 have happened only twice — during the Depression and during this latest collapse in 2008 and 2009. In the mid-1970s, we got close but stayed just above zero. After all three of these events, the S&P 500 had a positive slope (appreciated) for multiple decades.

S&P 500 chart

Chart S&P 500

In looking at the upward slope of the market after the Depression and the mid-1970s, we believe history suggests that stocks are in for a multi-decade move higher on a rolling 10-year annualized return basis.

During the past three years, $268 billion has been pulled out of stock funds, while $644 billion has migrated into bond funds. Stocks now have logged two years of out-performance relative to almost every other major asset class. And, as funds follow performance, we may be seeing the first signs that the tide is starting to roll back in. One week in late December, for example, stock funds took in a net of $8 billion, while bond funds attracted only $1.2 billion following three straight weeks of outflows.

The chart below shows the CBOE Volatility Index (VIX) for the past three years. The VIX is essentially the volatility index for the S&P 500. And volatility is the single biggest factor in determining the price of options. High volatility means high-priced options, while low volatility means low-priced options.

As you can see from the chart below, volatility is near a three-year low. Options are inexpensive.

VIX Chart

Chart of VIX

Better yet, we believe the market will appreciate by more than most analysts expect. The combination of low-priced options and a bullish, bigger-than-expected move by the market bodes well for calls.

Again, we believe the call for 2011 is to buy CALLS.

Article printed from InvestorPlace Media,

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