How To Learn To Stop Worrying And Love Omicron

How To Learn To Stop Worrying And Love Omicron
Stéphane Renevier, CFA

over 2 years ago4 mins

  • To protect your portfolio against Omicron, you could buy into gold, which has a lot of room to rise and not too much downside unless the US economy really takes off.

  • Or you could long consumer staples stocks and short the S&P 500, which would be especially effective if consumer staples do as well as they did during last year’s crash.

  • Or you could roll out the “1x2 options structure”, specifically on two exchange-traded funds: HYG and SPY.

To protect your portfolio against Omicron, you could buy into gold, which has a lot of room to rise and not too much downside unless the US economy really takes off.

Or you could long consumer staples stocks and short the S&P 500, which would be especially effective if consumer staples do as well as they did during last year’s crash.

Or you could roll out the “1x2 options structure”, specifically on two exchange-traded funds: HYG and SPY.

Mentioned in story

The arrival of the Omicron variant has gotten global investors spooked, in turn encouraging them to protect their portfolios by rotating into vaccine stocks like Pfizer and stay-at-home stocks like Zoom. But while those stocks might benefit if the situation gets worse, they stand to underperform if it doesn’t. So here’s a few trade ideas that could gain a lot more if Omicron causes a crash than you could lose if it doesn’t...

Trade idea #1: Buy gold

Gold tends to outperform when inflation is rising, the US dollar is weakening, sentiment is souring, and interest rates are falling. That means it’s been trading in a range recently: higher inflation has been working in its favor, sure, but a stronger dollar, bullish sentiment, and the prospect of higher rates have all put a ceiling on its price.

If the Covid situation keeps getting worse, however, there could be a shift in that landscape: the dollar could drop off, investors could turn against expensive-looking stocks, and the pressure to raise interest rates could soften. And if cryptocurrencies fail to perform because they’re more averse to risk, investors might flock back to the shiny metal, with that influx of cash supporting prices even more.

What’s the upside and the downside of this trade?

The downside of buying gold is arguably limited, unless we see a strong recovery in the US that pushes government bond yields and the US dollar higher. The upside, meanwhile, is seriously attractive: gold’s recently been dismissed by investors, and it could catch up quickly if the Omicron variant threatens the recovery.

Gold prices have been trading in a range. Source: Koyfin
Gold prices have been trading in a range. Source: Koyfin

Trade idea #2: Buy consumer staples stocks, short the S&P 500

Consumer staples stocks are companies that provide everyday essentials like food, clothing, and cleaning products. Unlike consumer discretionary or “cyclical” stocks that tend to rise and fall with the level of economic activity (think travel and construction), consumer staples are less impacted by a slowdown since their goods and services are always in demand. We still need to eat, dress, and wash, after all.

Still, while those stocks are more defensive than plenty of other stocks, they aren’t completely immune to recessions and likewise tend to fall in value when markets crash. So here’s a solution to make them really defensive: buy consumer staples stocks and simultaneously short the stock market. That way, you’ll be betting on the outperformance of consumer staples stocks over the rest of the market, and you stand to gain if it crashes. And if it doesn’t, you’ll benefit from the consumer staples stocks, meaning you’ll lose less than you would by simply shorting the stock market.

What’s more, you’re effectively paid to implement this “long-short” trade, since the dividend yield on consumer staples is higher than the wider market’s. If you were to short the S&P 500 directly, you’d have to pay the dividend while betting against a market with strong momentum.

What’s the downside and upside of this trade?

The downside is arguably limited, as the S&P 500 has already outperformed consumer staples stocks significantly. For the S&P 500 to continue significantly outperforming, we’d need to see a strong recovery and investors to go back to full “risk-on” mode, which seems unlikely before the end of the year. And the upside could be much higher, as consumer staples stocks could outperform the broader markets by double digits – just like they did in March 2020 – if risk aversion returns.

Consumer staples stocks have room to outperform the wider market
Consumer staples stocks have room to outperform the wider market

Trade idea #3: The ”1x2” options strategy

This is for investors who think things might get much worse from here, but can’t discard the possibility they’ll also get better. A 1x2 put ratio structure allows investors to bet on a significant crash. But unlike buying a put option, the structure is free to implement. You could even get paid for implementing it, if you structure it well.

You can find out more about how to implement the trade in one of my previous Insights, but here’s the potted version: sell a slightly out-of-the-money put option, and buy twice the amount of deeper out-of-the-money put options, making sure the price paid for the option you buy isn’t higher than the premium you receive for the one you sell.

There are two exchange-traded funds that could be good candidates to apply the structure on: the “junk bond” iShares iBoxx $ High Yield Corporate Bond ETF (ticker: HYG, expense ratio: 0.48%), and SPDR S&P 500 ETF Trust (ticker: SPY, expense ratio: 0.09%).

Payoff of a 1x2 put ratio
Payoff of a 1x2 put ratio

What’s the upside and downside?

This trade idea is the ultimate asymmetric opportunity: you make a killing if markets crash, but don’t lose anything if they rally. The only scenario where you lose is if they drop only slightly, but even then your losses are limited.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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