By Jay Soloff,
The funny thing about stocks this year is that it feels like we’re having a rough year. The last few months have brought quite a bit of volatility to the market, and with it comes the feeling that the stock market is struggling.
However, looking at the numbers, you may be amazed to see the S&P 500 is actually up 16% for the year. Moreover, the Nasdaq-100, comprised of most of the big tech names, is up over 20%. It doesn’t feel like a big up year for stocks, but it has been precisely that.
Most likely, investors feel like stocks have been struggling because most of the gains came before the summer. While we haven’t seen a correction so far this year, stocks are about 6% off 52-week highs. There’s almost always a recency bias when it comes to investing, so it should be of little surprise if investors have soured on the market.
Anecdotally, it seems like more investors are bearish on the remainder of the year. The uncertainty of the China trade war is weighing on stocks. There’s also been mixed signals from the Fed on its willingness to cover for the self-imposed battle of tariffs between the US and China.
On one hand, the Fed cannot ignore adverse economic developments, regardless of the cause. On the other hand, some in the Fed believe it’s not a prudent course of action to let the administration pursue controversial economic policies simply because the Fed can bail the U.S. out if the policies backfire.
Of course, all of this may be moot if lowering interest rates stop being a crutch for the economy. After all, there’s only so much further rates can go before getting into negative territory.
So what’s all this mean for stocks?
I took a look at options action in the Invesco QQQ Trust (QQQ) to see what traders think about the possibility of a Nasdaq-100 rebound. It turns out; there’s a least one considerable, very bullish trade which recently hit the tape.
A trader bought 1 million shares of QQQ at $186.17 while selling 10,000 December 20th 208 calls for $0.72. This covered call trade brought in $720,000 in premium, which works out to a 0.4% yield in not quite 17 weeks. The max gain is capped at $208, but that’s 12% higher from current levels.
Clearly, it’s a very low yield. Annualized we’re only talking about 1.2%. However, the dividend yield on QQQ is only 0.8%. If this covered call trade is made roughly every four months, the annual yield of holding QQQ shares climbs to a total of 2%.
And that is very likely the goal of this trade. Hold QQQ and keep the upside potential in the index, but earn 2% in yield over the course of the year. After all, tech stocks aren’t generally known as income stocks but are rather purchased for their growth potential.
In that respect, 2% isn’t a bad yield at all to receive for stocks with significant upside potential. And let’s not forget how low rates are right now and could be close to zero by year’s end.
Ultimately though, you have to view this trade as extremely bullish. If getting to $208 by the end of the year seemed impossible, the trader would have used a lower strike to collect more yield.
If you want to make a similar trade, it may make sense to use a lower strike and cap the upside of QQQ in exchange for higher income from the calls. However, if you use QQQ as your aggressive growth component in your portfolio, selling a much higher call like the trade above does make sense.
This article was sponsored by Tim Plaehn, expert on income investing and a friend & colleague of mine at Investors Alley as well as a contributor here on SeekingAlpha. Tim runs the Dividend Hunter newsletter which offers a solid & diverse selection of attractive high yield plays. The service now has 9,000 active subscribers and can be had HERE for the rock bottom price of $49 (It usually is $99) for the first year. There are few better bargains around for those looking for solid income plays to balance their high beta holdings especially when equities get volatile!