When the Dow is down 2,000 points one day, up 700 the next, then down another 1,400, most investors want to run and hide.
As Sven Henrich, founder and lead market strategist at NorthmanTrader, noted in a blog post last week, it’s a “dangerous market for any participant.” But for some active traders, the volatility has provided pockets of opportunity.
“If you speak to those who are experienced who have been through a few downturns in the past, they won’t necessarily say this is exciting, but they are knowledgeable enough and experienced enough to know there are opportunities out there you can take advantage of,” says Randy Frederick, vice president of trading and derivatives at Charles Schwab.
Some of those taking advantage include big banks like Barclays, which booked about $250 million in trading revenue on March 16, according to a report by Business Insider. JPMorgan also saw trading volumes hit records for some products, according to the report, as the bank (alongside Citigroup) raked in roughly $500 million more in revenue this year (versus the same time last year) across its equity derivatives franchises, per Bloomberg.
Pershing Square’s Bill Ackman was able to win big on a bearish hedge strategy made about a month ago, the Wall Street Journal reported. Ackman protected his portfolio with a $27 million hedge via credit protection on global investment-grade and high-yield bond indexes—and cashed in a nice $2.6 billion when he recently closed out the positions, according to a letter to investors on March 25 (helping offset losses on the portfolio).
Yet for many traders and institutions, the name of the game is largely to make lemonade from lemons. “A lot of people have asked me, ‘Wow, are market makers and professional traders killing it? They must be doing really well’—I really don’t think so. As a matter of fact, I would applaud the market making community and the high frequency trading community for keeping their liquidity going,” Andrew McOrmond, managing director of ETF trading solutions at WallachBeth Capital, tells Fortune.
For McOrmond, the trajectory of the market is clear: “This is essentially a one-way market: down.” That makes the kinds of strategies traders are using to book profits, in some cases, somewhat creative.
Where are the opportunities?
As any trader will tell you, volatility typically means opportunity.
And markets have seen unprecedented volatility in recent weeks, with the VIX index (often used as a fear gauge on the Street) hitting over 80, readings not seen since 2008. For daily active traders (especially of options), that means one thing: Prices for protection are skyrocketing.
Options premiums, particularly for put options, have gotten “as expensive as we’ve ever seen,” says McOrmond, which makes it costlier to pay for protection for some trading strategies right now.
Charles Schwab’s Frederick notes that a couple of strategies have enhanced potential for experienced retail investors to profit too. Writing covered call options on a stock you own (meaning you’re selling someone the right to buy your stock at a later date) likely won’t be written one to two months out in the current environment—but Frederick suggests a smart move now, as volatile as the market is with an unknown bottom, is to write covered calls five to six months out. “Because the volatility is so high, maybe [you] can sell some at a nice profit,” he says, and traders will get paid a lot more now for taking on the risk. For investors who wrote covered calls a month or two ago, Frederick says, they’ve likely closed them out (and bought them back) at a profit to help offset losses.
Trading options spreads (buying one and selling one option) is a “significantly better choice” than just buying long calls or puts in the highly volatile environment because it can help neutralize roughly 75% to 90% of the volatility, Frederick suggests. That helps the trade become (mostly) a price change trade (versus one that has to account for the cost of volatility).
Selling out-of-the-money put options is also a strategy traders could turn to, says Russell Rhoads, head of research and consulting at EQDerivatives, because “in a higher implied volatility environment, you’re getting paid more to sell those options.” He suggests some of the “smarter” traders are also cutting trade size as well.
But others, like WallachBeth’s McOrmond, are seeing success in one-time leveraged ETFs—notably Direxion’s daily S&P 500 Bear 1X Shares SPDN, an ETF that is more liquid than options spreads. “You’re just basically being short the market” with the ETF, he explains.
And of course, says McOrmond, some professionals have bucked the market’s downward trend, pointing to firms like Horizon Investments, Anchor Capital, Stadion Money Management, and CMG Capital Management. These “rules-based” RIAs and investment managers were able to “lighten up” on the market when sell signals started ringing (based partly on things like 50-day and 200-day moving averages) and sell at the end of February and beginning of March—before markets hit their current lows.
For one, Stadion’s tactical strategies have helped mitigate the impacts of the drawdown compared to the market, McOrmond notes, and its Trilogy Alternative Return Fund (STTIX) was up over 4% from late February to the beginning of March (the fund is up over 1% in the past month, whereas the Dow is down roughly 21% in the past month). Anchor Capital’s strategy, meanwhile, has been hedging volatility this year by investing in a core basket of ETFs, then managing the overall long and short exposure with futures—its Risk-Managed Equity Fund, ATESX, is down about 1% year to date compared to the S&P 500’s roughly 24% decline.
Still, even though some banks, institutions, and managers are finding pockets of profit, McOrmond maintains traders aren’t necessarily loving this environment—they’re making the best of it. Of WallachBeth’s clientele of RIAs, hedge funds, and institutions, “We don’t know one that’s bragging about the situation,” he says.
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