A private equity security for an uncertain market
The stock market is fun to talk about, as are sports and politics, but it’s so complex that it’s hard for most people to understand.
So, the next time someone wants to chat about the financial markets, these talking points will come in handy. “I can’t believe the bond market is sending signals of recession and the stock market is heading back to record highs,” you might say. Or the
Cboe Volatility Index
is broken. It’s about 19 years old, even though World War III is still possible, interest rates are rising and geopolitics is less stable than American politics.
You could also say something suave, like stocks are discounters, but J Pow (the cool way to refer to Federal Reserve Chairman Jerome Powell) is behind the economic curve. If the conversation just doesn’t end, shrug your shoulders, pull out your phone, and walk away saying you need to place an OTC trade overnight for oil in a foreign market.
These lofty talks are increasingly framing discussions in the marketplace, making it harder than usual to isolate actionable and illuminating signals from noise — or information with no economic value.
If you’d rather do more than just talk, consider taking a Stocks First approach: focus on well-run companies that have smart management teams and, ideally, pay dividends.
(ticker: KKR) in the past, and the private equity firm will always help you keep the noise down. As a company, KKR has a knack for being in the right place at the right time. He has an intriguing global investment portfolio and knows when to buy and how to take profits. KKR, for example, was one of the first investors in
Academy Sports and Outdoors
(ASO) and recently exited with a nice profit. Additionally, KKR has a dividend yield of 0.98%.
In early February, when KKR stock was around $73, we suggested investors consider selling the March $70 put option and buying the March $75 call option. March, a so-called risk reversal strategy, i.e. selling a put option and buying a call option with the same expiration. The put and call premiums canceled each other out, so the only costs associated with the transaction were the commissions and, potentially, the purchase of the shares.
KKR stock then fell after the company announced its fourth quarter results later that month, despite relatively strong results. If you followed our advice, you almost certainly own KKR stock now. Still, stocks hit a low of around $50 in mid-March and have since rebounded around 17% from the low. Investors seem to be concluding that rising interest rates will not hurt private equity firms and that the stock market laggards could once again be the market leaders.
KKR stock is poised to break through its 200-day moving average around $66, a critical test that could determine whether the stock is retracing more lost ground or falling lower.
Doing nothing right now – and waiting for the many defining market events to occur – is a legitimate decision. Still, aggressive investors can position themselves to buy KKR at a lower price as they await more gains ahead of KKR’s first-quarter earnings report in early May, a potential stock-moving event.
With KKR at $59.31, the May $55 put could be sold for around $1.55 and the May $65 call could be bought for around $1. If the stock were to rise, say, to $70, the call is worth $5. If the stock falls below $55, investors can either buy the stock or adjust the sell position to avoid the sell-off.
The risk inversion strategy is one of many ways to implement a Stocks First approach. Anyone who agrees with this course of action can, of course, decide on their own options strategy. The key to holding stocks with options is trying to bend market realities to reflect your views.
Steven M. Sears is President and Chief Operating Officer of Options Solutions, a company specializing in asset management. Neither he nor the company has a position in the options or the underlying securities mentioned in this column.
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