Volatility on the Potomac
The fat politician has not yet sung. The drama in Washington is not over. The only rational interpretation of the past week's extraordinary tumult is that volatile volatility is the only certainty and there will be plenty to go around over the next six weeks.
The mini-détente between House Republicans and the White House over the debt ceiling most likely ensures six weeks of erratic movements in the CBOE Volatility Index (VIX), which was unusually volatile during the past week as the market was whipped around by Washington.
Yes, investors are disgusted with Washington but they still like stocks, even though they mistrust the stock market. This seeming contradiction is a key theme in what is now an incredibly nuanced options market.
This dispersion reflects positive investor sentiment into earnings season on stocks, propelled by constructive economic data and the Federal Reserve's easy-money policies.
The mistrust toward the broad market shows the Street's stance toward Washington has changed. A week ago, the Street was playing chicken with Washington and buying bullish calls because no one thought Congress was insane enough to wreck the nation's pristine credit rating over political differences. Now, investors are not so sure. Many are playing the volatility metronome just in case. When it seems the stock market may collapse based on Washington headlines, they buy VIX calls or futures. When everything seems OK, they switch to VIX puts.
The trading pattern is highly reactive, and that is a good sign for stocks because it suggests Wall Street views Washington as a tactical trade-not a systemic risk. This is a key tell into the market. If investors were bracing for dire news from Washington, they would probably buy hedges that expire in three months or more to guard against severe market fallout. That investors instead focus on short-term trades to capture sharp market moves is a sign the bull party continues.
ONE TRADE TO CONSIDER during these bifurcated times is a put sale on Facebook (ticker: FB) paired with a stock purchase. Credit Suisse is telling clients a solid third-quarter earnings report on Oct. 30 could make the social-media stock an excellent addition to the Standard & Poor's 500 index.
Because index and exchange-traded funds are required to buy S&P 500 index additions, the stocks get a boost, and much of the Street scrambles to get a piece of the index-addition rally. Credit Suisse estimates almost $10 billion of Facebook stock would trade if the shares are added to the index.
Aggressive investors can consider buying Facebook's stock and selling Facebook's November $47 put that was bid at $2.84 when the stock was $49.62. If the stock advances on earnings, the money kept for selling the put can be kept, provided the stock does not slide below the put strike price before expiration.
The wind is at Facebook's back. The stock is up about 80% this year, indicating phenomenal momentum that will most likely push the stock higher if earnings are robust. In the past month, eight of the 39 analysts who follow the stock have increased their earnings estimates.
Should earnings disappoint, and the stock declines on profit-taking, put sellers are obligated to buy the shares. Owning Facebook stock shouldn't be terribly painful, and not just because of the index addition trade. Facebook's last earnings report showed the company was making progress in the mobile-advertising business, which many investors believe is like a magical unicorn with a money-printing machine, and that is a nice thing to keep around the portfolio, especially if Congress upsets the market's tense, delicate equilibrium.
STEVEN SEARS is the author of The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails.Comments:steve.sears@barrons.com, http://twitter.com/sm_sears
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