- CPI data indicated inflation could’ve hit its peak, but investors aren’t in the clear just yet.
- Goldman breaks down why buy-write trading strategies are “increasingly popular” with investors.
- As markets weather volatility, the investment bank recommends options trades with these 4 stocks.
On Thursday, stocks soared after key consumer price data indicated inflation levels may have peaked.
The consumer price index rose 7.7% in the year through October, weaker than economists had forecast, according to the Labor Department. Both the Dow Jones Industrial Average and the S&P 500 notched their biggest one-day rallies since 2020 on the news.
We’re not in the clear yet though. Just last week, Federal Reserve Chair Jerome Powell said that it was still “very premature to think about pausing” interest rate hikes.
“This morning’s CPI data were a welcome relief, but there’s still a long way to go,” Lorie Logan, the president of the Federal Reserve Bank of Dallas, said after the report.
As investors speculate over the print and looming recession fears, many are looking for bets that can withstand various macro environments. In a recent note to clients, Goldman Sachs breaks down this options trading strategy that the investment bank says has an 18-year track record of adding extra income to investors’ pockets.
Providing extra income for 18 years
These are “buy-write strategies,” which is when an investor holds a stock long-term while selling a call positions on the same underlying asset. This strategy, according to the Nov. 7 report, has outperformed the total returns of the S&P 500 on a risk-adjusted basis for nearly 20 years.
Goldman Sachs Global Investment Research
“These strategies have become increasingly popular among investors, especially given the prospects of flat to negative equity markets. Options provide asymmetric exposure to the underlying asset, unlike stock or stock-like investments. This property helps provide a downside cushion to covered call sellers, in the form of a premium,” Arun Prakash, a vice president at Goldman Sachs, wrote in the Derivatives Research report.
Prakash added: “This premium, especially when viewed in the context of a systematic strategy, is often viewed by investors as similar to interest or coupon payments, and leads to outperformance over stocks in flat to negative equity markets.”
For short-term overwriting options trades, the note focuses on three factors when choosing an “attractive” stock: events, implied volatility, and market cap of the company.
“We identify stocks that do not report earnings prior to the next expiration where their market cap is in the top 2/3 of the universe and their implied volatility is also in the top 2/3,” Prakash wrote.
Snap (SNAP), Block (SQ), Twilio (TWLO), and Southwestern Energy (SWN) could be key overwriting choices in the near-term, specifically for November and December expirations. Each of these picks, per the firm, could lead to premiums ranging from 6.4% to 7.7%.
“We have found that overwriting stocks with these characteristics has added over 500 bps over the past 16 years,” the note said.
Prakash recommended overwriting these stocks with December 10% out-of-the-money calls.
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