Late-cycle option strategies

October 2019

Later stage equity markets are typically characterized by increased levels of volatility. Options may provide a way to take advantage of volatility spikes, and even potentially profit from them. 

In this video, Eric Augustyn, Wells Fargo Investment Institute Director of Option Strategies, explains how options may be used as a viable addition to a diversified portfolio for appropriately qualified investors.

Transcript: Late-cycle option strategies

Title graphic: Volatility and the market 

As the stock market enters the later stages of a bull market, volatility tends to increase as uncertainty regarding economic growth begins to take hold. This year, the change in Federal Reserve policy from tightening to easing, the U.S.-China trade tensions, and the impeachment proceedings have compounded that volatility. 

Chart: S&P 500 Volatility (October 2009 to October 2019). Source: Bloomberg, October 1, 2019. An index is unmanaged and not available for direct investment. 

The CBOE Volatility Index, or VIX, averaged 17% over the last year, and volatility seems to be moving back in line with longer-term averages—which could mean a higher general level of volatility. 

In reality, the path of market volatility is slightly more nuanced, with bouts of below-average volatility for extended periods, followed by bursts of episodic volatility. 

Title graphic: Implications and opportunities 

Historically, volatility rarely stays “high”; it’s a bit like the seismograph of an earthquake—small shocks at first, then a big jump, then aftershocks before settling to a lower level. Investors can look at these jumps in volatility as an opportunity.

Chart: S&P 500 Volatility (October 2018 to October 2019). Source: Bloomberg, October 1, 2019. An index is unmanaged and not available for direct investment. 

Options may provide a way to take advantage of these volatility spikes and even potentially profit from them. Option strategies can be utilized to help mitigate the negative effects of market fluctuations on asset values, as well as seek to enhance returns, regardless of volatility intensity. These strategies provide a unique way to manage traditional portfolios when used as an overlay on existing stock and bond portfolios.

Investors can use protective strategies in effort to minimize declines in value. These are strategies that may focus on specific holdings or diversified portfolios. In a higher volatility market, investors may also utilize income generating strategies or specific strategies designed to diversify a concentrated stock position over time.

Title graphic: Summary and takeaways

Later stage equity markets are typically characterized by increased levels of volatility. This higher volatility has generally meant higher prices for option contracts. Investors would typically hedge, or utilize a protective strategy, in effort to protect against these higher levels of volatility or may utilize income generating strategies for potential income opportunities.

Options may be used as a viable addition to a diversified portfolio for appropriately qualified investors. Options are complex and carry risk, but in the right situation, they can be used to help appropriate investors meet their financial objectives. Contact your investment professional for more information on these strategies.

Options involve risk and are not suitable for all investors. Before opening an option position, please read “Characteristics and Risks of Standardized Options” carefully before investing. This document is available from your Financial Advisor or the Options Clearing Corporation, 125 S. Franklin Street, Suite 1200, Chicago, Illinois 60606. Supporting documentation for any claims, comparison, recommendations, statistics or other technical data will be supplied upon request.