The Striking Price

Why It’s Time to Hold Stocks

Saturday, February 21, 2015

Amid high stock prices, many investors want to unload equities. But there’s a case for using calls to increase equity exposure.

Stock prices are trading around record highs and many investors want to sell stocks and buy calls. The trade makes perfect sense: It locks in stock profits, reduces capital at risk, and allows investors to participate in future gains.

But the trade ignores two key facts that make the case for investors raising their equity exposure by buying calls to amplify potential profits, and holding onto their stocks.

“Alas, things always go lower, as well as higher, on Wall Street because in the short-term the markets are fear, hope, and greed only loosely connected to the business cycle,” Jeff Saut, Raymond James’ market strategist, reminded clients Friday, evidencing enough weltschmerz for at least a couple of Goethe novels.

When interest rates rise, as many expect later this year, equities tend to rise as well, RBC’s Jonathan Golub said. “When rates go up, it is good for stocks,” he says.

Golub’s 2015 price target for the S&P 500 is 2325, well above the recent 2089.

Moreover, a structural imbalance between bonds and stocks should boost stock prices. A chart making its way around the Street shows a $1.63 trillion spread between bond-fund inflows and equity-fund outflows from January 2007 to January 2013. Over that period, $1.23 trillion flowed into bond funds and $409 billion exited equity funds.

The spread—some say the largest ever—suggests stocks will receive a massive influx from the bond market sparked by the Federal Reserve’s expected rate hike. The bond market may not fare so well.

Hence, investors should boost their stock exposure—and not sell stocks. Selling puts, which are a bit pricey on fears of a correction in the Standard & Poor’s 500 index, could lower the cost of buying calls when so many stocks and indexes are trading at high prices.

January SPDR S&P 500 ETF (ticker: SPY) calls with strike prices slightly above the market are attractive. The same trade structure works for sector stocks. Contrarians may find it hard to ignore the unloved Select Sector SPDR-Financial (XLF) and other battered sectors. Hot money loves relative value.

IVERS W. RILEY, one of the exchange industry’s most innovative executives, died Tuesday in Savannah, Ga. He was 82.

Riley was recently on Interactive Brokers ’ (IBKR) board of directors. He was the chairman of the International Securities Exchange from 2002 to 2006. At the American Stock Exchange, he led the development of the first exchange-traded fund, the SPDR S&P 500 ETF, which became one of Wall Street’s most successful products. He also worked at the New York Stock Exchange, Chicago Board Options Exchange, and Hong Kong Futures Exchange.

Riley was an elegant man with an easy smile. He had an athletic grace, and it was easy to imagine him as the naval aviator he once was. “Everybody liked him,” Thomas Peterffy, Interactive Brokers’ chairman said. “He was simple, straightforward, and always encouraged people to do the right thing.”

Riley’s experience was so deep that he understood how trading would evolve years before others.

“He was involved in many of the transformative moments that set the course for the robust options markets in existence today,” said David Krell, ISE’s chairman and co-founder, in a statement. “From convincing the SEC to allow trading of puts, to developing the first ETF products, to leading the industry toward the benefits of electronic trading, Ivers had a clear vision driven by a desire for innovation and transparency.”

Riley was diagnosed last year with cancer, his son Michael G. Riley says. He will be buried next to his wife at Bonaventure Cemetery in Savannah, Ga.

Reprinted by permission of Barron's Online, © 2015 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

The views expressed in the above papers and articles are solely those of the author of the article, and do not necessarily reflect the views of OIC; the information presented is not intended to constitute investment advice or recommendations to purchase or sell securities of any company; and the information presented is based upon particular events that may or may not recur in the future.

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