We’ll review a strategy for investors who are hesitant to buy this dip, but don’t want to miss out on a potential comeback. Volatility spikes from time to time, and the stock market corrects from time to time. This is known. Generally, these two things go hand in hand. Markets decline, volatility spikes, complacency turns to fear, and often, a fearful market presents better buying opportunities; as Warren Buffett famously said, “Be greedy when others are fearful.” A high Cboe Volatility Index (VIX) statistically is followed by above-average returns. Since January 1990, the 1-month returns for the S & P 500 have averaged just over 80 basis points (1 basis point equals 0.01%). However, the average 1-month returns for the month going forward when the VIX is 30 is nearly triple that. Moreover, historically, the market has been higher about 64% of the time over one month. .VIX YTD mountain Cboe Volatility index, YTD Still, when the VIX was greater than 30, a level it breached on Monday this week, the market was higher roughly 77% of the time a month later. Knowing this, and with the S & P lingering close to Monday’s closing price net of Wednesday’s declines, deploying more capital to equities may seem tempting. If some doubt lingers, it may be because although the market has dropped somewhat precipitously since the all-time highs of July 16th, the S & P 500 is still up about 9% this year, and the market hasn’t formally experienced a correction. Black Friday might not see consumers lining up at all hours if Best Buy was offering TVs 8.5% off. Prices are better than they were a couple of weeks ago, but they aren’t cheap by comparison. The follow-up question might be: Why did the VIX close above 30 on Monday if equities haven’t fallen to correction territory? It got far higher than that intraday. Don’t those spikes typically correspond to full-on corrections if they are not bear markets? They do. Since January of 1990, the earliest date for which we have VIX Index data, only one period, other than this one, saw the VIX close above 30 without the market entering correction territory or a bear market either a month prior or the month following, and that one prior period was in the days leading up to the 2020 election. It was a time of extraordinary uncertainty when the market was exiting the pandemic plunge. The trade Could this period be a similar anomaly? High volatility without at least a market correction? Perhaps since it is a presidential election year, but if you’re concerned about further pullbacks, it may be wiser to use call spreads to make bullish bets than committing new capital to equities. A call spread offers defined risk and mitigates the higher options premiums elevated volatility creates. An example? Buying SPDR S & P 500 ETF Trust (SPY) January $525 call options and selling nearer dated September $550 calls against them in a diagonal spread. SPY YTD mountain SPDR S & P 500 ETF Trust (SPY), YTD This is sometimes referred to as the “poor man’s covered call,” so called because it costs less than purchasing the underlying shares to write calls against. That lower cost also means a lower defined risk because the total risk is limited to the premium spent on the spread. Trade example: Bought Jan. 17 $525 Call Sold Sep. 30 $550 call A higher VIX usually translates to higher short-term returns for the S & P 500, but that is also because the higher VIX usually corresponds to steep selloffs, and this selloff, while certainly painful, hasn’t reached correction territory…yet. DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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