It just seems like there is no stopping this stock market. The economy stinks. Q1 retail numbers were abysmal. Q1 GDP was -2.9%. The national debt continues to explode. Obamacare is forcing businesses to cut employee hours. Wages are stagnant while inflation moves higher.
However, “Don’t fight the tape” is one of the most famous Wall Street sayings, and that’s the truth. When the market has momentum in a given direction, it is difficult to play the opposite side of that trade. Shorts can get wiped out when the market keeps moving higher. Longs can get slaughtered if the bears tear their eyes out.
The Dow Jones Industrial Average’s one- and three-year average total returns have been 14.2% and 13.1%. The S&P 500’s one- and three-year average total returns have been 22.9% and 16.1%. These are pretty amazing returns, and if you think there’s more to come — but want to hedge your bets somewhat — naked puts are for you.
My strategy: Sell naked puts against index ETFs for each of the three big indices. If the market moves higher, you’ll have collected the premium and made some money without exposing yourself to the risk of intraday fluctuations. If the ETF gets put to you, you’ve hedged your actual entry point thanks to the premium you’ve collected. (Just remember, you have to have the funds available to purchase any ETFs should those funds get put to you.)
Take a look.
Naked Puts on the SPDR Dow Jones Industrial Average ETF (DIA)
The SPDR Dow Jones Industrial Average ETF (DIA) trades at $169.86, just off its all-time high. I suggest selling the DIA ETF’s Aug 22 $170 naked puts for $2.47. That’s a modest 1.45% for a seven-week holding period, or a 10.8% annualized return.
As a note: What you’re doing is trading off full upside potential, so it makes sense that the annualized yield on DIA ETF puts would be a modest 10.8%.
Naked Puts on the PowerShares QQQ Trust (QQQ)
The PowerShares QQQ Trust (QQQ) is the ETF for the Nasdaq-100, which we would expect to have a higher premium due to the overall higher volatility of the stocks in the index.
The QQQ trades for $95.41 as of this writing. The QQQ Aug 22 $95.50 naked puts sell for $1.58. That’s a 1.65% return for a seven-week holding period, or 12.4% annualized.
Higher risk means higher return.
Naked Puts on the SPDR S&P 500 ETF (SPY)
The SPDR S&P 500 ETF (SPY) trades at $197.51. Once again, the variety of strike prices works in your favor here. You can sell the SPY Aug 22 $197.50 naked put for $2.67. That’s a 1.4% return for a seven-week holding period, or 10.5% annualized.
Again, think about the risk you would otherwise take if you purchased the SPY ETF outright. You might enjoy huge gains, but you could get hit with a big loss. This way, you get a decent return with reduced risk.
One other thing — what happens if one of these naked puts gets put to you?
Let’s say the SPY ETF gets put to you at $197.50 and perhaps the ETF trades at $197 on expiration day. You collected $2.67 per share in premium, and lost 51 cents in capital gain, leaving you with a net gain of $2.16. Then turn around and sell the Sep $196 call. You now have a covered call position, and can keep selling puts or calls as long as you wish.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at email@example.com and follow his tweets at @ichabodscranium.