Traders Unite!

In a Frothy Stock Market, This Might Be Your Best Move

A 12-year-old bootblack in Manhattan in 1924.

Lewis Hine/Library of Congress

It’s one of the market’s greatest legends. Just before the crash of 1929, the stock market was in an epic bull market. Lower Manhattan was filled with shops that let people wager on rising stock prices as if they were betting on dogs, or ponies, or boxing.

A shoeshine boy gave Joseph P. Kennedy a stock tip, and Kennedy, reasoning that the market had grown far too frothy, sold off all his stocks instead. Kennedy was out of the market when the crash ravaged America, securing a dynastic fortune that would help propel his son John F. Kennedy to the presidency.

Now, almost 100 years later, the market construct has seemingly changed. The shoeshine boy’s figurative heirs have grown rich buying stocks, digital currencies, and other risk assets. Anyone who worried too much has missed out.

Activity has reached a fever pitch. The options market, which enables investors to magnify their stock bets at relatively low cost, has seen daily trading volumes rise to about 40 million contracts a day, up from maybe a million in 2000.

Still, even as the S&P 500 index continues to dance around record highs, many investors are left biting their nails. We need not enter into the usual risk recital that starts with the expected end of the Federal Reserve’s easy-money policies and ends in a global inflationary spiral. Instead, let us focus on something that is reasonably concrete: volatility and trading volumes in stocks and options.

When good times or bad times roil the markets, investors trade, and this benefits brokerage firms, investment banks, and others like them. Investors who want to benefit could consider trading options on Interactive Brokers Group stock (ticker: IBKR). The low-cost, technologically sophisticated brokerage is well poised to profit from volatility swings.

The company just reported reasonably good third-quarter earnings. Chairman and founder Thomas Peterffy told investors he believes the company can sustain 30% new account growth. Piper Sandler analyst Rich Repetto, who has a Buy rating on Interactive Brokers stock, has told clients the company benefits from rising rates.

Intrigued investors can consider buying Interactive Brokers’ January $80 call option and selling the January $70 put option. This “risk reversal” strategy—that is, buying a call and selling a put with a lower strike price, but similar expiration—could be executed at zero cost when the stock was at $75.

If Interactive Brokers stock is at $85 at expiration, the call is worth $5. The short put obligates investors to buy the stock at $70 if the stock is at that price or lower at expiration.

The January expiration will cover two meetings of the Fed’s interest-rate setting committee, countless economic reports, and many other events that could move markets higher or lower. Should something change to scare investors, or embolden them, Interactive Brokers would likely benefit, too.

During the past 52 weeks, the stock has ranged from $46.71 to $80.57. It is up about 23% this year.

There is a broader message from the options market that is worth noting. Stock prices might be high, but options premiums are arguably not as robust. The Cboe Volatility Index, or VIX, at 15.5, looks as if it might fall to the lowest levels of the year despite all those looming risks.

Yes, a low VIX indicates investor complacency, but it also means that options can be used to control stocks without paying a dramatic fear or greed premium—and that is worth considering when there is so much of each swirling about.

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.

Email: editors@barrons.com

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