There is a growing tension in the stock and options markets that could lead to a disruptive impact. As the S&P 500 Index continues to climb towards record levels, sell-side portfolio strategists are becoming more positive, but the trading community remains skeptical. Many traders are concerned about a potential corrective pullback in the stock market, especially as the Cboe Volatility Index (VIX) rose along with stocks on Monday, indicating that some investors are buying put options as a hedge against a possible downturn.
The Fear of missing out (FOMO) phenomenon is also driving stock prices higher, fueled by optimistic economic reports and the belief that the Federal Reserve will not need to raise interest rates. In such a market environment, options can be a more cost-effective alternative to stocks. Call options, in particular, can offer significant upside potential at a lower cost than buying shares outright.
One strategy to consider in this market environment is the bullish spread, which involves buying one call option and selling another with a higher strike price and the same expiration. This strategy allows investors to benefit from an advance in the stock within a specific price range. In the case of Broadcom, a chip stock poised for growth due to AI enthusiasm, investors could consider buying the December $1,900 call and selling the December $2,100 call. This strategy could yield a maximum profit of $134 if the stock reaches $2,100 by expiration.
While the bullish spread strategy limits exposure to stock gains beyond the highest strike price, it offers a potential return of 203% if the stock performs as expected. This strategy is particularly attractive for long-term investors looking to avoid capital gains taxes on stock sales while still enjoying the benefits of market gains.
In conclusion, the tension building in the markets presents both challenges and opportunities for investors. By considering strategies like the bullish spread and focusing on stocks with strong growth potential like Broadcom, investors can navigate the market uncertainties and potentially profit from the current market dynamics.
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