Also: A 6% rule for retirees, ARKK’s surge and a way to beat its performance, how to handle family money conflicts, and year-end Medicare, retirement and tax-planning tips.
SPDR S&P 500 ETF Trust
Surge in bullish bets could help push stocks higher as $2.4 trillion in options set to expire Friday.
Traders have piled into call options linked to popular U.S. equity exchange-traded funds as U.S. stocks rallied following the release of Tuesday’s consumer-price index.
That could help push stocks even higher in the days ahead, options-market strategists said.
Options tied to $2.4 trillion in stocks, exchange-traded funds and equity indexes are set to expire on Friday, according to data compiled by Rocky Fishman, founder of Asym50, a provider of analytics about the U.S. options market.
A chart from a team of analysts at Goldman Sachs Group showed that call buying tied to popular index-tracking exchange-traded funds exploded this week, causing the ratio of outstanding calls to puts tied to the SPDR S&P 500 ETF Trust
the Invesco QQQ ETF
and the iShares Russell 2000 ETF
to sink as traders dumped puts and piled into calls. This ratio is typically referred to as “skew” in Wall Street parlance.
Notably, skew for calls tied to the IWM, the ETF tracking the Russell 2000, a popular index of small-cap stocks, has sunk to its lowest level on record, according to Goldman’s data, signaling unbridled bullishness in a previously unloved corner of the marke.t
Brent Kochuba, founder of SpotGamma, a provider of options-market data and analytics, told MarketWatch that the shift in small-cap skew has been “super interesting.”
With roughly one-third of calls tied to the IWM set to expire on Friday, some of the momentum that has driven small caps sharply higher over the past two weeks could fade if traders opt not to roll over their positions.
But the spike in demand could also be a sign that more traders will pile into small caps in the hopes that they will continue to climb, as corners of the U.S. market that have lagged Big Tech all year continue to play catch up.
Call options represent bullish bets on an underlying security or index. Put options represent the opposite. Options can be used to speculate on market direction, or to hedge an investor’s portfolio.
Hello! This is MarketWatch reporter Isabel Wang bringing you this week’s ETF Wrap. In this week’s edition, we look at how ETF investors can navigate the choppy financial markets which remain on edge after a sell-off in U.S. government bonds drove long-term borrowing costs to the highest level in more than a decade, undercutting stock prices.
Sign up here for our weekly ETF Wrap.
A renewed rout in the U.S. government bond markets that sent the yield on the 10-year Treasury bond to 16-year highs as a new era of higher-for-longer interest rates takes hold, is leaving ETF investors scrambling for the exits on a wide range of exchange-traded funds in the past week, most notably the iShares 20+ Year Treasury Bond ETF
TLT, one of the most popular fixed-income ETFs that tracks a market-weighted index of the U.S. Treasury bonds with maturities of 20 years or more, earlier this week suffered its lowest close since the early days of the 2007-2009 financial crisis. The yield on the 10-year Treasury
slipped 2 basis points to 4.715% on Thursday, after reaching 4.801% on Tuesday, its highest closing level since Aug. 8, 2007, according to Dow Jones Market Data.
The bond market, particularly the U.S. Treasury market, has historically been less volatile and and has often performed better than other financial assets during economic slowdowns. However, that doesn’t mean bonds don’t come without their own risks.
Rising yields reflect a diminishing price for the securities when interest rates rise, and hit existing holders of Treasuries.
The surprising strength of the U.S. economy, as demonstrated by this week’s labor-market data, coupled with hawkish talk from Federal Reserve officials indicating the central bank may need to keep tightening monetary policy, have led to the bond sell-off this week.
Meanwhile, a positive Treasury term premium, or the compensation that investors require for the risk of holding a Treasury to maturity, have also contributed to a steep sell-off as a ballooning U.S. budget deficit and the Treasury’s need to issue more debt have pushed Treasury prices to 16-year lows.
has fallen over 50% since its peak in August 2020, according to FactSet data. The losses are “pretty much” what the equity-market loss was from peak to trough during the global financial crisis, said Tim Urbanowicz, head of research and investment strategy at Innovator ETFs.
“It is not insignificant… It really makes you think about how you’re doing risk management because you can’t have the piece of the portfolio that’s supposed to be the risk mitigator falling the worst we’ve ever seen in the equity-market fall. That’s a big issue,” Urbanowicz told MarketWatch.
That’s why ETF investors have very few options when developing or adjusting their asset allocation play in the higher-for-longer rates environment, but there are still some shockproof assets for safety, according to ETF strategists.
Ultra short-term bond funds
ETF investors that still favor bonds can consider hiding in ultra short-term bond funds to avoid duration risk as the Fed may still need to raise interest rates to curb inflation by the end of 2023, said Neena Mishra, director of ETF research at Zacks Investment Research.
The SPDR Bloomberg 1-3 Month T-Bill ETF
which tracks all publicly issued U.S. Treasury Bills that have a remaining maturity of less than 3 months and at least 1 month, offers a yield of 5.43%. The fund attracted over $1 billion of inflows in the week to Wednesday, the largest inflows among over 800 ETFs that MarketWatch tracked in the past week, according to FactSet data.
Meanwhile, Mishra said investors who want active management with “better navigation to the markets” can consider the JPMorgan Ultra-Short Income ETF
which is an actively managed fund that invests in a variety of debts including corporate issues, asset-backed securities, and mortgage-related debt as well as U.S. government and agency debt. JPST recorded $15 million of inflows in the past week and has yielded 5.76%, according to FactSet data.
Flows into longer duration bonds, utilities sector
Despite the bond rout hitting the popular TLT fund hard as the 10-year Treasury yield surged, some retail traders have already started to buy the historic dip of the fund devoted to longer-dated Treasuries, said a team of Vanda Research data analysts led by Marco Iachini, senior vice president.
TLT attracted a total of $686 million flows in the week to Wednesday, ranking the 8th out of over 800 ETFs that MarketWatch tracked in the past week, according to FactSet data.
Along with the strong “dip buying” in TLT, retail traders have also poured an “unprecedented amount” of capital into the utilities sector, Iachini and his team said in a Thursday note. The Utilities Select Sector SPDR Fund
recorded $141 million of inflows last week, according to FactSet data.
“While purchases of utilities stocks are typically of a significantly smaller scale than purchases of tech stocks, the inflow seen over the past week is far larger than any other prior 5-day stretch, easily surpassing inflows into the sector at the onset of the Covid downturn,” the Vanda team said. “The flip side of this dynamic is that institutional investors have likely lightened up their utilities exposure during this bond sell-off episode, making the sector a potentially more appealing equity bet should rates be nearing a local peak.”
Small-caps are ‘cheap for a reason,’ so don’t buy them too soon
Many small-cap stocks have traded at a significant discount to their larger-company counterparts, creating an attractive entry point for some investors who think the forward price-earnings ratio for small-caps are low enough to offer potential for outperformance in the longer run.
“It is really important right now not to just rely on a specific sector but really have that built-in risk management at the index level to take a lot of that guesswork out of the equation,” he added.
That’s why Urbanowicz and his team at Innovator ETFs think the increasingly popular defined-outcome ETFs, or the “buffer” funds, could limit the downside risk and help investors navigate a stormy rates environment.
For example, the Innovator Equity Defined Protection ETF
the “first-of-its-kind” fund, aims to offer investors the upside return of the SPDR S&P 500 ETF Trust
to a 16.62% cap, as well as a complete buffer against its downside over a two-year outcome period.
Meanwhile, the Innovator Defined Wealth Shield ETF
offers a 20% downside buffer on the SPY every three months, which is a “very shortened outcome period” and doesn’t require the equity market to actually go up for the strategy to appreciate a value, Urbanowicz said.
“A big reason [to consider this strategy] is it gives investors a place to not only maintain equity exposure, but also to hide out because they [funds] have known levels of risk management that are in place,” he added.
As usual, here’s your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.
…and the bad
AdvisorShares Pure U.S. Cannabis ETF
Sprott Uranium Miners ETF
Global X Uranium ETF
VanEck Oil Services ETF
SPDR S&P Oil & Gas Exploration & Production ETF
|Source: FactSet data|
J.P. Morgan Asset Management Friday announced the launch of a new actively managed hedged equity ETF, JPMorgan Hedged Equity Laddered Overlay ETF
The outcome-oriented ETF invests in U.S. large-cap equities with a laddered options overlay designed to provide downside hedging relative to traditional equity strategies.
Zacks Investment Management Tuesday announced the launch of the Zacks Small and Mid Cap ETF
which seeks to generate positive risk-adjusted returns by investing in small and mid-cap companies.
Calamos Investments LLC Wednesday announced the launch of the Calamos Convertible Equity Alternative ETF
the first product of its kind to provide ETF investors with targeted access to equity-sensitive convertibles.
Weekly ETF Reads
The stock market, as measured by the S&P 500 Index
is still trapped within its trading range. However, when SPX traded down through its 20-day Moving Average this week, coupled with the FOMC meeting’s conclusion, that seemed to get the ball rolling on the downside.
This is also a seasonally weak period for the market, so that is potentially contributing to the bearish argument as well. The support at 4330 is what really matters, though, and as long as that holds, SPX is still in its trading range that extends back several weeks. The upside of the trading range is 4540. A breakdown below 4330 or a breakout above 4540 should give the market some strong momentum in the direction of the breakout.
Since SPX has been in this trading range, realized volatility has decreased. Those calculations are based on closing prices; many trading days have had volatile intraday moves, only to see prices close little changed. As a result, the “modified Bollinger Bands” are now relatively close together. Even so, SPX has not touched either of the +/-4σ Bands, so our McMillan Volatility Band (MVB) buy signal remains in place.
Equity-only put-call ratios have moved sideways and even begun to roll over. If they roll over that would be a new buy signal. To the naked eye, both have rolled over to some extent. The computer analysis programs are statistical, though, and consider what is coming off the 21-day moving average. With that in mind, the analysis programs rate the standard ratio as a “buy,” but have not yet given that designation to the weighted ratio. Hence, only the standard ratio’s chart has a green “B” on it.
Breadth has been very negative of late — especially “stocks only” breadth (i.e., the breadth of all stocks with listed options). Both breadth oscillators – the other being the NYSE oscillator — have been on sell signals since September 6th. They remain on those sell signals, and now the “stocks only” oscillator has descended into oversold territory. Surprisingly, NYSE breadth has been quite a bit better, so that oscillator is not yet oversold. In any case, oversold does not mean buy, so these oscillators are still bearish.
Plus, there is a new sell signal from the “New Highs vs. New Lows” indicator. This week, New 52-week Lows on the NYSE numbered greater than 100 issues for two consecutive days (and on both days, New Lows were greater than New Highs). That constitutes a sell signal. This sell signal will remain in force until New Highs outnumber New Lows for two consecutive days. We had a strong, long-lasting buy signal from this indicator this past March. We shall see if this one has the same staying power.
The above “internal” indicators are somewhat bearish, but the volatility-based indicators remain generally positive for stocks. This has been the case all along, for months and months. VIX
has bounced off its yearly lows at 13 several times in the last four months. Thus, the trend of VIX buy signal remains in place as long as VIX continues to close below its 200-day Moving Average (which is at 17.80 and declining). VIX has not even entered “spiking” mode, which would occur today on a close by VIX above 17.00. In other words, VIX continues to have a “no-worry” policy regarding the stock market (so far).
The construct of volatility derivatives remains generally bullish for stocks, too. The term structures of the VIX futures and of the CBOE Volatility Indices continue to slope upwards. The 9-day VIX (VIX9D) popped up just before the FOMC meeting earlier this week but is back down now after the meeting’s conclusion (even though the stock market is reacting badly to the meeting’s conclusion). Furthermore, the 1-year VIX (VIX1Y) just made a multi-year low this morning, as it is falling sharply. Apparently, there is selling of SPX options a year out. This is the lowest the 1-year VIX has been since February 2020.
We are not carrying a “core” position as long as SPX remains between 4330 and 4540. However, we are trading individual indicator signals as they are confirmed.
New sell signal
As noted above, the “New Highs vs. New Lows” indicator has generated a sell signal. The last signal from this indicator was a buy signal last March that was quite successful. It remains to be seen whether this one will have that kind of staying power.
Buy 1 SPY
Oct (20th) at-the-money put
And Sell 1 SPY Oct (20th) put with a striking price 20 points lower.
We will hold this position until New Highs outnumber New Lows on the NYSE for two consecutive days.
New recommendation: Chef’s Warehouse (CHEF) puts
CHEF broke down badly to a multiyear low this week, and there has been a strong increase in bearish option activity. One could make an argument for this stock returning to the 2020 basing area, in the 12-18 range.
Buy 3 CHEF Nov (17th) 25 puts
In line with the market.
: 23.63 Nov (17th) 25 put: 2.20 bid, offered at 2.50
Since the breakdown has been so sharp, the trailing stop is at 26.50 for now. As time passes, we should be able to tighten that closer to the stock price.
All stops are mental closing stops unless otherwise noted.
We are using a “standard” rolling procedure for our SPY spreads: in any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread, or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.
Long 8 CRON
Oct (20th) 2 calls: Option volume continues5to be very strong. Hold without a stop.
Long 2 EW
Oct (20th) 75 puts: Sell these puts if EW closes above 76.
Long 4 SPY Sept (29th) 480 calls: This is the position taken in line with the CVB buy signal. We are holding SPY calls with a striking price equal to SPY’s all-time high. We are holding without a stop.
Long 1 SPY Oct (20th) 448 put: Bought in line with the equity-only put-call ratio sell signals. If you bought more than one, you might want to sell half, because the standard ratio has rolled over to a buy signal (but the weighted has not). Otherwise, we are going to hold this put until the weighted ratio rolls over to a buy.
Long 2 NTAP
Oct (20th) 80 puts: Sell these puts now, since the weighted put-call ratio has rolled over a buy signal.
Long 2 EQR
Oct (20th) 65 puts: We will continue to hold as long as the weighted put-call ratio for EQR remains on a sell signal.
Long 3 X
Oct (13th) 31 calls: Hold without a stop while takeover offers are sort out.
Long 2 PSX
Oct (13th) 123 calls: There has not been any specific news here, but the stock has roared ahead. Set a stop at 118 for these calls.
Long 1 SPY Oct (20th) 446 call and Short 1 SPY Oct (20th) 464 call: This spread was bought in line with the MVB buy signal of August 29th. This signal will remain in place unless SPX closes below its -4σ Band, which would stop out the signal. The target for the trade is for SPX to touch the +4σ Band.
Long 3 ADM
Oct (20th) 82.5 puts: We will hold this position as long as the weighted put-call ratio for ADM is on a sell signal.
Long 5 TSHA
Oct (20th) 2.5 calls: The stop remains at 2.75.
Long 4 BKR
Oct (20th) 37 calls: The trailing stop remains at 35.80.
Long 0 DIS
Oct (13th) 81 puts: These puts were stopped out when DIS closed above 83.70 on Sept 14th.
Long 2 SPY Sept (29th) 444 puts: Bought in line with the seasonally bearish period in the week after September expiration. Since SPX has traded down, sell half of your position. The remainder should be sold at the close of trading on Friday, Sept. 22.
Long 10 TEVA
Oct (20th) 10 calls: Stop yourself out on a close below 9.75.
All stops are mental closing stops unless otherwise noted.
Send questions to: email@example.com.
Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of the best-selling book, Options as a Strategic Investment. www.optionstrategist.com.
©McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.
Investors in index funds have been well rewarded by a high concentration in the largest technology companies over the past decade. But there are also continuing warnings about the risk of such heavy concentrations, even in index funds that track the S&P 500. Solutions are offered to limit this risk, but if you expect Big Tech to continue to drive the broad market returns over the coming years, why not make an even more focused bet?
Comparisons of three index-fund approaches highlight how successful concentration in the “Magnificent Seven” has been.
and Meta Platforms Inc.
We have listed them in the order of their concentration within the Invesco S&P 500 ETF Trust
which tracks the S&P 500
The U.S. benchmark index is weighted by market capitalization, as is the Nasdaq Composite Index
and the Russell indexes.
SPY is 27.6% concentrated in the Magnificent Seven. One way to play the same group of 500 stocks but eliminate concentration risk is to take an equal-weighted approach to the index, which has worked well for certain long periods. But here, we’re focusing on how well the concentrated strategy has worked.
Let’s take a look at the group’s concentration in three popular index approaches, then look at long-term performance and consider what happened in 2022 as rising interest rates helped crush the tech sector.
Here are the portfolio weightings for the Magnificent Seven in SPY, along with those of the Invesco QQQ Trust
which tracks the Nasdaq-100 Index
and the Invesco S&P 500 Top 50 ETF
|Company||Ticker||% of SPY||% of QQQ||% of XLG|
|Alphabet Inc. Class A||GOOGL||2.17%||3.12%||3.83%|
|Alphabet Inc. Class C||GOOG||1.88%||3.11%||3.32%|
|Meta Platforms Inc. Class A||META||1.77%||3.60%||3.12%|
|Sources: Invesco Ltd., State Street Corp.|
The same group of seven companies (eight stocks with two common share classes for Alphabet) is at the top of each exchange-traded fund’s portfolio, although the top seven for QQQ aren’t in the same order as those for SPY and XLG. QQQ’s weighting was changed recently as the underlying Nasdaq-100 underwent a “special rebalancing” last month.
Here’s a five-year chart comparing the performance of the three approaches. All returns in this article include reinvested dividends.
QQQ has been the clear winner for five years, but it is also worth noting how well XLG has performed when compared with SPY. This “top 50” approach to the S&P 500 incorporates many stocks that aren’t listed on the Nasdaq and therefore cannot be included in QQQ, which itself is made up of the largest 100 nonfinancial companies in the full Nasdaq Composite Index
Examples of stocks held by XLG that aren’t held by QQQ include such non-tech stalwarts as Berkshire Hathaway Inc.
Johnson & Johnson
Procter & Gamble Co.
Home Depot Inc.
and Nike Inc.
Now let’s go deeper into long-term performance. First, here are the total returns for various time periods:
|ETF||3 Years||5 Years||10 Years||15 Years||20 Years|
SPDR S&P 500 ETF Trust
Invesco QQQ Trust
Invesco S&P 500 Top 50 ETF
Click on the tickers for more about each ETF, company or index.
There is no 20-year return for XLG because this ETF was established in 2005.
For five years and longer, QQQ has been the runaway leader, but for 5, 10 and 15 years, XLG has also beaten SPY handily, with broader industry exposure.
Something else to consider is that during 2022, when SPY was down 18.2%, XLG fell 24.3% and QQQ dropped 32.6%.
For disciplined long-term investors, the tech pain of 2022 may not seem to have been a small price to pay for outperformance. And it may have been easier to take the pounding when holding SPY or even XLG that year.
Here’s a look at the average annual returns for the three ETFs:
|ETF||3 years||5 years||10 years||15 years||20 years|
SPDR S&P 500 ETF Trust
Invesco QQQ Trust
Invesco S&P 500 Top 50 ETF
So the question remains — do you believe that the largest technology companies will continue to lead the stock market for the next decade at least? If so, a more concentrated index approach may be for you, provided you can withstand the urge to sell into a declining market, such as the one we experienced last year.
Here is something else to keep in mind. In a note to clients on Monday, Doug Peta, the chief U.S. investment strategist at BCA, made a fascinating point: “The only novel development is that all the heaviest hitters now hail from Tech and Tech-adjacent sectors and are therefore more prone to move together than they were at the end of 2004, when the seven largest stocks came from six different sectors. “
Nothing lasts forever. Peta continued by suggesting that investors who are tired of big tech taking all the glory “need only wait.”
“[I]f history is any guide, their time at the top of the capitalization scale will be short,” he wrote.
Want to diversify your stock-market investments away from top-heavy indexes? Here’s another easy way.
The broad U.S. stock indexes are weighted by market capitalization, which can work out well during a bull market, as success is rewarded and index-fund investors have growing allocations to the large-cap stocks that have risen the most. But it can also concentrate a high percentage of your money into a handful of companies.
There are different ways to mitigate this risk. One is to broaden your exposure by adding index funds to your portfolio that aren’t weighted strictly by market capitalization. This can be done with an equal-weighted index fund, and Barry Bannister, an investment strategist at Stifel, expects this approach to outperform the S&P 500 over the next several months.
Another index fund that can broaden your horizons is the Invesco S&P 500 GARP exchange-traded fund
Nick Kalivas, Invesco’s head of factor and core equity product strategy, described the fund’s methodology and discussed its recent performance. GARP stands for “growth at a reasonable price.”
You might be happy with a low-cost fund that tracks the S&P 500
After all, the average annual total return for the $408 billion SPDR S&P 500 ETF Trust
has been 12.5% over the past 10 years through Monday, according to FactSet. For the entire 10-year period, SPY’s return has been 225%. (All returns in this article assume dividends are reinvested and are after expenses.)
Apple alone makes up 7.2% of the SPY portfolio.
Another popular index fund, the $198 billion Invesco QQQ Trust
tracks the Nasdaq-100 Index, which had gotten so concentrated that its largest five components made up more than 45% of the total before the index underwent a special rebalancing last month. Even now, the top five holdings of QQQ — Apple, Microsoft, Amazon, Nvidia and Meta Platforms Inc.
— make up 34.1% of the portfolio, with Apple alone at 11.2%.
Long-term investors who have been thrilled with the performance of SPY and QQQ over the years might also worry about a 2022-like scenario, when SPY fell 18.2%, led by the S&P 500 information-technology sector, and QQQ dropped 32.6%.
If you have been pouring money into these or similar cap-weighted index funds through regular investments, you might not want to make radical moves from your index funds. Maybe you could move some money into funds with broader exposure, or perhaps you might direct new investments into other funds.
Getting back to the S&P 500 GARP ETF
this fund changed its strategy to its current one in June 2019. The fund’s portfolio is reconstituted and rebalanced twice a year, on the third Fridays of June and December. Here’s how it has performed over the past three years:
Keep in mind that this is only a three-year performance snapshot and that a longer history wouldn’t really be valid, because SPGP’s strategy changed in June 2019. Its outperformance against SPY and QQQ reflects its better performance during the bear market of 2022. So far this year, SPGP has returned 13%, trailing returns of 38% for QQQ and 17% for SPY. This in part reflects QQQ’s very heavy concentration to the largest tech-oriented companies.
In an interview, Kalivas said SPGP’s underperformance relative to SPY so far this year has resulted in part from “some of its exposure to financial stocks during the SVB and Signature Bank dislocation.” Silicon Valley Bank of San Francisco and Signature Bank of New York both failed in March.
The returns are after expenses, which are 0.33% of assets under management annually for SPGP, 0.095% for SPY and 0.2% for QQQ. SPGP is ranked five stars (the highest ranking) by Morningstar within the investment information firm’s U.S. Fund Large Blend category, while SPY is ranked four stars in the same category. QQQ has a five-star rating within Morningstar’s U.S. Fund Large Growth category.
SPGP tracks the S&P 500 GARP Index, which is maintained by S&P Dow Jones Indices. The stock-selection methodology begins with the full S&P 500. Companies are ranked by growth scores based on increases in earnings per share and sales over the trailing 12 reported quarters. After narrowing the list to 150 companies scoring highest for growth, S&P Dow Jones Indices does further screens based on the companies’ returns on equity and ratios of debt to equity and price to earnings.
After a quality score is assigned to each of the 150 companies, the list is pared to the 75 with the highest quality scores. These are then weighted by the growth score for the portfolio. The weighting is limited so that the individual company weightings will range from 0.05% to 5% and that no sector will have more than a 40% weighting.
Here are the top 10 holdings of SPGP:
|Company||Ticker||Industry||% of the Invesco S&P 500 GARP ETF||Forward P/E|
|Diamondback Energy Inc.||
||Oil and Gas Production||2.2%||7.9|
|Marathon Petroleum Corp.||
||Oil Refining/ Marketing||2.2%||8.4|
|CF Industries Holdings Inc.||
|Steel Dynamics Inc.||STLD||Steel||1.9%||9.2|
|Coterra Energy Inc.||CTRA||Integrated Oil||1.9%||10.8|
|APA Corp.||APA||Integrated Oil||1.8%||7.8|
|EQT Corp.||EQT||Oil and Gas Production||1.7%||11.3|
|Sources: Invesco, FactSet|
Click on the tickers for more about each company, including business profiles, financials and estimates.
At first glance, we are looking at a concentration to energy and materials. This may be surprising, with those sectors underperforming the broad market this year. But Kalivas said the allocation reflected the scoring of the companies by growth and quality.
Here is the fund’s current sector allocation:
The portfolio is “quite dynamic,” Kalivas said. S&P Dow Jones Indices tested the methodology for the S&P 500 GARP Index going back to the 1990s and found that energy-sector exposure would have ranged from zero to 33%. The allocation “moved around very much, depending on where the growth is,” he said.
Even though SPGP’s methodology is based on growth, the approach also brings value to the fore. The forward price-to-earnings ratios of the listed companies are based on current stock prices and consensus earnings estimates for the next 12 months among analysts polled by FactSet. The ratios are low when compared with the weighted forward P/E of 21.7 for the S&P 500. There is no forward P/E for Moderna Inc.
because the consensus among analysts is for the company to book negative earnings for three of its next four quarters.
Kalivas said SPGP would be ideal for investors “who are worried about paying too much.”
Wall Street blamed zero-day option traders for a sudden stock-market selloff. But a BofA team says they got it wrong.
Did a group of traders in rapidly expiring options recently drag the S&P 500 lower in the final hour of trading? Or has the influence of this booming corner of the options world been exaggerated?
A team of equity-derivative strategists at Bank of America
Global Research think it is the latter. In a research report shared with clients on Tuesday, the team argued that the impact of rising zero-day, or “0DTE,” volumes has been more benign than many on Wall Street believe.
0DTEs stand for zero days to expiration. They are option contracts typically linked to the S&P 500 or an S&P 500-tracking exchange-traded fund, like the SPDR S&P 500 Trust
which have 24 hours or less until they expire.
Analysts at Goldman Sachs Group
Nomura and other banks homed in on price action in stocks on Aug. 15, when the S&P 500 shed roughly 0.4% in a 20-minute period that also saw a flurry of trading in 0DTEs. The S&P 500 closed 1.2.% lower for the session, its biggest daily percentage drop in about two weeks, according to FactSet data.
Their thesis is that a wave of puts with a strike price around 4,440 moved into the money, forcing market-makers to hedge their positions by selling stocks and futures.
But a team of analysts at BofA has a different interpretation of what happened. To be sure, they acknowledged that 0DTE trading volume has grown dramatically in August to record highs. According to the team, eight of the 10 highest notional-volume days for S&P 500-linked 0DTEs occurred in the past 30 days.
The debate comes as investors endure a punishing month of August in stocks and bonds, sparked partly by a selloff in long-dated Treasurys that saw the 10-year yield
touch its highest since 2007.
Through Friday, options on the verge of expiration were on track to see their busiest month ever in terms of notional volume traded. They also were on track to see records in terms of the number of contracts traded, as well as their share of total trading volume in S&P 500-linked options.
Zero-day options in their current form are fairly new. But trading in these options has boomed since last year when the CME Group and Cboe Global Markets, two major U.S. derivatives exchanges, introduced weekly options on certain indexes and ETFs with expirations every day of the trading week.
Options give owners the right, but not the obligation, to buy or sell a given security at an agreed-upon price on or before an agreed-upon expiration date. Puts carry the option to sell, while calls carry the option to buy.
While the BofA team thinks 0DTEs have the potential to drive intraday instability in markets, a view that’s shared by many on Wall Street, they questioned the notion that zero-day option put buyers were responsible for what happened on Aug. 15.
Data cited by several Wall Street strategists showed roughly 100,000 0DTE put options with a strike at 4,440 changed hands after 3 p.m. Eastern. However, BofA’s analysis concluded that buy-side traders were net sellers of these contracts, not net buyers, as other analysts have concluded.
Therefore, the team surmised that hedging by market makers, which other analysts have blamed for the sharp move lower in the S&P 500, didn’t have much of an impact, suggesting the late-day decline was likely driven by other factors like rising Treasury yields or trading by systematic quant funds.
“…[T]he impact 0DTEs may have had last week was clearly greatly overstated. Instead, other factors such as systematic quant flows…and the renewed impact of higher rates on equities may have been more relevant,” the team said.
To be sure, analyzing option-market flow data isn’t an exact science, leaving some room for interpretation as analysts try to discern whether a given trade involved a buy-side trader buying calls or puts from a market maker, or something else, according to Brent Kochuba, founder of SpotGamma, a provider of data and analytics for the derivatives market.
U.S. stocks have fallen since the start of August, with the S&P 500
down 4.4% through Tuesday’s close, according to FactSet data. The Nasdaq Composite
has fallen by 5.9%, while the Dow Jones Industrial Average
is down 3.6%.
It’s that time again: monthly stock-market options for August are set to expire on Friday, potentially spurring more volatility in stocks after a bruising three-week run.
U.S. stock option contracts with a notional value of $2.2 trillion are set to expire, according to Rocky Fishman, founder of newly formed strategy firm Asym 500 and a former head of index derivatives strategy at Goldman Sachs Group. Notional value measures the market value of the stocks, indexes and exchange-traded funds controlled by the options, although the premiums paid by holders of the options are worth much less.
Fishman noted that the size of option-market open interest expiring on Friday is about average for an off-month expiration.
Monthly options expire every month, but once a quarter — in March, June, September and December — an event known as “Triple Witching” takes place, causing notional value of expiring options to swell as quarterly and sometimes calendar-year options expire along with monthlies and weeklies.
Sessions where monthly options expire often see higher-than-normal volatility, and options-market analysts warned that the same could happen on Friday.
Charlie McElligott, a longtime derivatives strategist who publishes research on Nomura’s trading desk, warned clients that option dealers are “short gamma” heading into Friday’s expiration, increasing the potential for option dealers to exacerbate market volatility. McElligott illustrated this tendency in the chart below.
Why are dealers short gamma, and what does this mean? As stocks have stumbled, option traders have been buying put options and selling call options. As a result, dealers could be forced to hedge their positions by buying futures if stocks rise and their customers close out their short-call positions, or selling futures to hedge the risk of puts moving into the money.
This would serve to exaggerate the market’s move in either direction, driving a rising market higher and a falling market lower, McElligott said.
Dealers could hit “peak short gamma” if the S&P 500 falls to 4,320, sending a wave of puts into the money. If that happens, it’s possible dealers could slam stocks lower as they rush to avoid being on the hook for puts sold to customers. The S&P 500
finished Thursday at 4,370.36.
Gamma is used by options analysts to describe how quickly an option’s delta changes. Delta represents how sensitive the price of an option is to moves in the underlying asset. When options are about to expire, delta typically increases dramatically, since small moves that put it closer to being in or out of the money can have a dramatic impact on the option’s price.
Brent Kochuba, founder of SpotGamma, also cited risks tied to dealers’ short-gamma position in research shared with clients. SpotGamma shares data and analytics about the option market.
“We have been watching market gamma fall into negative gamma territory all month. Once it entered that range, price action became visibly choppier, as expected during these conditions,” he said in written commentary shared with MarketWatch and SpotGamma clients.
Option contracts give traders the right, but not the obligation, to buy or sell the underlying asset or currency. Often, options tied to stock-market indexes like the S&P 500 are settled in futures or cash. Options tied to exchange-traded funds like the SPDR S&P 500 ETF Trust
which tracks the S&P 500 index, are settled in shares of the ETF.
A put option allows the buyer the right, but not the obligation, to sell shares at an agreed-upon price known as the “strike price.” A call option, conversely, gives the holder the right to buy shares. Put options tend to appreciate when the underlying stock or index falls, while the opposite is true for calls.
U.S. stocks finished lower on Thursday, with the S&P 500 and Nasdaq Composite poised to record a third straight weekly decline, what would be the longest such streak for the S&P 500 since February.
In addition to monthly options expiring Friday, weekly options known as “zero days until expiration” or “0DTE” options could further complicate the market’s reaction. A veteran Goldman Sachs Group strategist warned earlier this week that 0DTE traders have been limiting upswings in stocks while piling on the pressure when markets sink.
Trading in risky ‘0DTE’ stock options hits record and could spark a stock-market selloff, strategists say
Trading in stock options with extremely limited lifespans is surging to record highs just as the 2023 U.S. stock-market rally is showing signs of stalling.
While in the past this this trade has been associated with subdued volatility in markets, some option-market experts fear the resurgence could set the stage for a selloff in the days and weeks ahead, depending on the reaction to major market-moving news like Thursday’s U.S. consumer-price index report.
According to data provided to MarketWatch by SpotGamma, a provider of option-market data and analytics, trading in so-called “0DTEs,” shorthand for “zero days until expiration,” touched its highest level on record last Friday, as volume as a percentage of all S&P 500-linked options hit 53%. The figure includes trading on options tied to the S&P 500 index
including those on ETFs like the SPDR S&P 500 ETF Trust
While 0DTE trading strategies were initially popularized by retail traders on social media like Reddit’s “Wall Street Bets” subreddit due to their risky all-or-nothing nature, the strategy is now overwhelmingly employed by institutional traders as a way to hedge their risk heading into events with potentially serious consequences for markets.
They are also used as part of tactical strategies that aim to profit from intraday swings in markets, option-market experts said.
Peng Cheng, a managing director at JPMorgan Chase & Co.
told MarketWatch that over the past month, only 4.3% of total 0DTE volume has been handled by retail traders, while the rest has been institutional traders and market makers.
U.S. stocks have seen a year-to-date rally stall since the start of August as investors have contended with a disconcerting news. Examples include the Fitch Ratings’ decision to abandon its AAA credit rating on U.S. debt, disappointing economic data from China, and flagging performance by stock market leaders like Nvidia Corp.
and Apple Inc.
0DTE traders have re-emerged to try to profit from these wider swings, experts said. The strategy received a lot of attention earlier this year for helping to keep stocks locked in a tight range between 3,800 and 4,200 on the S&P 500.
But data show volume tapered off in June after the S&P 500 index saw a decisive break above 4,200 as the 2023 stock-market rally accelerated. More recently, volumes have started to bounce back as the rally has slowed.
Brent Kochuba, founder of SpotGamma, which provides options data and analytics, said elevated 0DTE volatility is typically associated with mean reversion.
That is, heavy 0DTE flows have a tendency to spark intraday reversals in markets as traders and market makers try to push the market to their advantage. For example, last Friday, the spike in 0DTE volume coincided with a selloff that pushed stocks into the red during afternoon trading in New York. A similar dynamic was on display on Wednesday, as stocks reversed early losses.
Kochuba said SpotGamma data suggest 0DTE strategies could keep the market “pinned” to the 4,500 level on the S&P 500.
“When we look at the intraday flow, there has been this flow that’s pushed mean reversion around 4,500,” Kochuba said during a phone interview with MarketWatch. “When the market tried to rally over 4,500 on Friday, a large 0DTE flow emerged and smacked the market back down.”
However, two top option markets strategists at Oppenheimer & Co. fear that overlapping crowded positions in derivatives markets that profit from a phenomenon known as “volatility suppression” could tip over into a selloff should the Cboe Volatility Index, otherwise known as the Vix or Wall Street’s “fear gauge,” continue to climb, as it has over the past week.
0DTEs are known for suppressing expectations about how volatile the market might be as measured by the Vix, since 0DTE trading volumes aren’t factored into the fear gauge. That could in theory increase the likelihood that markets are blindsided by a sudden outbreak of volatility.
Alon Rosin and Sam Skinner at Oppenheimer told MarketWatch during a phone interview that the market has recently tested the daily ranges within which option market makers expect it to trade. One example he cited was Aug. 2, the day after the Fitch U.S. credit-rating cut, when the S&P 500 saw its biggest pullback since April.
When this happens, it increases the risk that market makers will need to rapidly hedge their positions, potentially sparking a sudden surge in the Vix and corresponding selloff in stocks.
What’s more, the trajectory of stocks and stock futures over the past week is sending a signal that could portend a further move to the downside.
“We’ve seen lower session lows in U.S. stock futures during five of the last six days,” Skinner said during the phone interview. “That’s not good.”
MarketWatch reached out to several option market-makers for comment, including Wolverine Trading, Optiver and Akuna Capital, but didn’t receive a response.
Other analysts have raised concerns about the potential for 0DTEs to exacerbate market stress during periods of panic, an issue that MarketWatch explored in a story published earlier this year.
Back in February, a top quantitative analyst at JPMorgan warned clients that 0DTEs could potentially spark “Volmageddon 2.0.” The original “Volmageddon” occurred on Feb. 5, 2018 as a popular short-volatility trade in derivatives markets collapsed, causing the collapse of an ETF that allowed retail traders to profit from bets that implied stock-market volatility would fall.
On that day, the Vix roughly doubled to nearly 40 while the Dow Jones Industrial Average
fell by more than 1,175 points. At the time, it was the biggest daily point decline on record for the blue-chip index.
“We’ve really only seen these options trade during a low volatility regime,” said Garrett DeSimone, head of quantitative research at OptionMetrics, a provider of analytics tied to the option market, during a call with MarketWatch.
“It is going to be really interesting to see what happens when you have a day where you have a 30+ reading on the VIX,” he said.
Meanwhile, the Dow
was down 20 points, or 0.1%, at 35,289.
Investors see warnings every day and under all economic conditions that the stock market is overvalued. Last year, high-flying technology companies led a broad decline for stocks, and many of those same companies have led this year’s rebound. With the market so heavily concentrated toward the largest tech names, you might now believe we’re near another frothy top. If so, the TrueShares Low Volatility Equity Income exchange-traded fund may be a well-timed investment choice.
The TrueShares Low Volatility Equity Income ETF
is actively managed, unlike most ETFs, which are designed to track stock indexes automatically. Austin Graff, the fund’s portfolio manager, explained how he selects stocks and pointed to sectors he believes investors should be focused on now.
First, let’s take a look how the 11 sectors of the S&P 500
and the broad indexes have performed this year, and compare their forward price-to-earnings ratios with those at the end of each of the past two years. (All returns in this article include reinvested dividends.)
The forward price-to-earnings ratios for most of the sectors and the indexes are below their levels at the end of 2021, but the valuation for the tech sector is almost as high as it was then. For perspective, the S&P 500’s current weighted forward P/E is 19.6, compared with a 10-year average of 18.9. The tech sector’s P/E is 27.7, compared with a 10-year average of 21.9.
We cannot predict how long the current bull market may last. When the Federal Reserve sends a clear signal that it is ready to take an extended break from raising interest rates, the stock market could make another upward move as investors look ahead to declining interest rates, which make bonds less attractive and can help support stock prices.
Meanwhile, Joseph Adinolfi considers how long momentum can drive a stock rally.
Weathering a storm
In an interview, Graff, who has previous experience as an investment banker at Goldman Sachs and as a fund manager at Pimco Investment Management, explained that he maintains a list of between 100 and 125 stocks within the S&P 500 of companies whose dividend yields are higher than that of the index, or that he expects to increase their dividend payouts at a more rapid pace than the index does as a whole.
Then he narrows the list by analyzing the “profit drivers” for the companies as part of a qualitative analysis “to select companies that can perform through the business cycle.”
“There are times when consumer cyclicals benefit because consumers have more money,” but selecting companies for investment based on those trends can lead to “more volatility of earnings and cash flow,” Graff said. “That is what we are not interested in owning.”
From his pared list, Graff typically holds between 25 and 35 stocks in the DIVZ portfolio, seeking to buy at attractive entry points and hold for the long term.
DIVZ pays its own dividends quarterly. The current dividend yield is 3.29%, compared with a yield of 1.43% for the SPDR S&P 500 ETF Trust
which tracks the benchmark index.
DIVZ was established on Jan. 27, 2021. Here’s how it has performed since then, compared with SPY:
These total returns are net of expenses, which are 0.65% of assets annually for DIVZ and 0.095% for the passively managed SPY. From its inception through Aug. 1, DIVZ has underperformed SPY, but it has been a smoother rise for investors. During 2022, SPY fell 18.2% while DIVZ had a positive return of 3.5%.
Buying on the (big) dip
When asked about recent purchases, Graff said he had scooped up shares of Charles Schwab Corp.
in May, following a decline of more than 30% for the stock after the brokerage firm, which relies heavily on its bank subsidiary, was “caught in some of the regional-banking crossfire.”
The three large U.S. bank failures this year — Silicon Valley Bank, Signature Bank of New York and First Republic Bank of San Francisco — had varying catalysts but ultimately resulted from runs on deposits. Shares of regional banks and Schwab fell not necessarily because investors feared more failures, but because of rising funding costs. Savers have been moving to get higher yields after so many years of being paid next to nothing by banks before the Federal Reserve began to raise interest rates last year.
“They have plenty of capital to get through the current environment,” Graff said about Schwab. The stock rose 11% on July 18, after Schwab Chief Financial Officer Peter Crawford said the deposit outflow had been slowing.
Another bank stock that Graff said he picked up at a good price was New York Community Bancorp
which has soared following the bank’s discounted purchase from the Federal Deposit Insurance Corp. of deposits and some assets from the failed Signature Bank of New York.
Here are the largest 15 holdings of the TrueShares Low Volatility Equity Income ETF:
|Company||Ticker||% of the TrueShares Low Volatilty Equity Income ETF||Dividend yield||Forward P/E|
|Charles Schwab Corp.||SCHW||5.01%||1.52%||17.4|
|UnitedHealth Group Inc.||UNH||5.00%||1.49%||18.9|
|British American Tobacco PLC ADR||BTI||4.57%||8.42%||6.7|
|Verizon Communications Inc.||VZ||4.39%||7.81%||7.1|
|Exxon Mobil Corp.||XOM||4.20%||3.41%||11.9|
|Philip Morris International Inc.||PM||4.17%||5.17%||14.9|
|Johnson & Johnson||JNJ||4.10%||2.82%||15.3|
|Lockheed Martin Corp.||LMT||3.80%||2.66%||16.3|
|American Electric Power Co. Inc.||AEP||3.80%||3.95%||15.4|
|New York Community Bancorp Inc.||NYCB||3.69%||5.00%||5.3|
Click on the tickers for more about each company, fund or index.
Graff commented further about his approach and the fund’s holdings.
He is especially interested in the healthcare sector now, which is among this year’s worst performers. After a decline in elective surgeries during the pandemic, Medtronic PLC
is now well-positioned, he said, because of rising sales for pacemakers and other medical devices. Medtronic’s shares have a dividend yield of 3.15%. He added that UnitedHealth Group Inc.
the fund’s second-largest holding, has said that an increasing number of elective surgeries are taking place.
In the utilities sector — this year’s weakest performer among the S&P 500 sectors — he likes FirstEnergy Corp.
of Akron, Ohio, because “it is cheap” and has a relatively high dividend yield, and because he expects new CEO Brian Tierney to improve the company’s management culture.
Graff also likes Broadcom Inc.
as a play on artificial intelligence. Nvidia Corp.
is dominating financial press coverage because of its leading position as a maker of graphics processing units used by data centers to help corporate clients deploy AI. But Graff believes Broadcom will also make out well during the AI build-out. “As they bring in chips to run more intense workloads, Broadcom is providing the network support for that setup — the switches and the routers for the data center,” he said.