The U.S. equities market in 2014 has been marked by an almost eerie calm amidst a prolonged period of near-record low volatility. For the Warren Buffets of the world, or those happy to watch the market slowly tick upward and reap the benefits of long-term investments, these market conditions are ideal. For active traders and investors, however, a stagnant market means little or no opportunities to find profit by taking advantage of price movements, or volatility. As some market experts have deemed this period the “new normal,” with no expectations of a return to sustained volatility, where can active traders and investors turn to find opportunities to profit?
1. Go long and leverage
Assume you want to buy a stock with a glimmer of hope that it might squeeze a couple dollars higher. If you have a large amount of disposable cash to invest, a 2 to 3 percent return over the course of a year may satisfy your investment goals. For those who want to get more bang for their buck, however, turning to leverage, or borrowed capital, may increase the potential returns of an investment as only a couple dollar move in the stock price will impact your account more positively.
Investors using cash accounts through a brokerage put up 100 percent of the value of a stock position, meaning that a one dollar increase in the stock price provides a 1:1 return ratio. Regulation T, or Reg T, allows investors to put up only 50 percent of the value of a stock position, and provides a 1:2 return ratio for overnight margining and 1:4 intraday margining return. Leverage is always good when you’re on the right side of the market, but if a stock decreases in value a leveraged investor may end up owing multiples of their initial investment!
2. Long stock/covered call strategy
What if you already own the underlying stock and want to make incremental gains without buying or selling your holdings? One strategy is to sell call options against it, or selling the rights to another individual to buy the underlying stock at a set price until the option contract expires. The closer the set price (call strike) to the underlying stock, the higher the premium received or the farther the call strike is out of the money, the less premium that will be received. The hope for the seller is that the stock never reaches the call strike, thus pocketing the entire premium. In a market with little or no movement, this can be a very lucrative strategy. This too can be very risky, because if a stock rallies above the call price and the option is exercised you have to deliver your stock. Another possibility is the stock price crashes where your short premium is not enough to cover the price decline.
3. Exchange Traded Funds
One of the most popular investment vehicles in today’s market, exchange-traded funds or ETFs, offer investors exposure to investment strategies above and beyond simply picking from U.S. equities. They can provide access to unique investment regions, sectors, commodities, bonds, futures and others. ETFs are essentially baskets of stocks, commodities or bonds that seek to track an index and provide benchmark returns. They are similar to traditional mutual funds, except that shares in an ETF are bought and sold throughout the day just as stocks are traded. Even more appealing, ETFs are known for generally having low expense ratios.
In periods of low volatility in the U.S. equities market, opportunities can be found in sectors that may be more attractive. Think emerging markets will continue to show strong growth? There are ETFs for that. Want to ride the wave of the U.S. shale gas boom? There is an ETF for that. Want to brag to your friends that you are invested in hedge funds? Yep, there is an ETF for that. The variety is almost endless, so if U.S. equities are not providing the returns you seek, get creative!
4. Binary options – a more simplified approach
Binary options offer traders a simple yes/no proposition on where they think the price of an underlying market may end up over a defined duration, generally a shorter period of time such as 2 hours, 1 day or 1 week. Due to the short timeframe, even when underlying markets are flat, individuals can take advantage of very small movements – or no movements at all – in price.
When trading binary options there are several considerations to take into account that affect profitability. The first, and most important consideration, is your opinion of the underlying market direction or lack thereof for this example. Secondly, how long to do you anticipate the underlying markets will remain flat? If the gold market is showing little movement then a binary contract against the price finishing above a particular price level in the next 2 hours may be a profitable position.
Strategies to consider in low volatility environments include focusing on binaries that are already “in the money”. These are binary contracts you can buy where the underlying market is already above the strike price or binary contracts you can sell where the underlying market is below the strike price. Further, if you choose a binary duration for a contract already in the money and well within a specific timeframe, the probability of profiting is greatly enhanced. Traders can deploy these strategies at risk profiles they are comfortable with. In other words, choosing a binary strike that is only slightly in the money means you are paying for less insurance, or taking on more trade risk but less dollar risk. Conversely, purchasing a binary strike that is well in the money means you are paying for more insurance, or are taking on less trade risk but more dollar risk. As an example, as long as the market remains flat and the binary is in the money, the contract has a higher probability of expiring worth $100. So if you paid $80 for the binary position (higher proportional cost out of the $100 contract value), then your net profit, not inclusive of exchange fees, would be $20 at expiration.
Dan Cook, Director of Business Development, Nadex
As Director of Business Development for the North American Derivatives Exchange (Nadex), Dan Cook is responsible for introducing Nadex to the broader trading community and providing education opportunities for traders to learn about the unique, limited risk contracts offered on Nadex.
With more than 15 years’ experience in the financial markets, Dan has served in many different capacities, giving him a broad, yet intricate knowledge of the current landscape. Prior to joining Nadex, Dan was the CEO and Senior Market Analyst of IG Markets, Inc., He has previously held positions as a Senior Broker and Trading Coach for Global Forex Trading. Before moving into futures and currencies, Dan focused on equities trading.