UBS lays out 3 ways traders can enter uncertain markets using turbulence to their advantage
- The stock market has absorbed a barrage of negative headlines since the start of the Covid-19 pandemic, leading to spikes in volatility.
- Headline-driven volatility spikes can often instill fear in investors and nudge them to sell their stocks at the worst possible time.
- According to a Friday note from UBS, volatility will likely remain elevated through the end of 2020 because of Covid-19, trade tensions between the US and China, and the upcoming 2020 US presidential election.
- Rather than sell into volatility spikes, investors should "harness" market turbulence to their advantage and defensively buy stocks, UBS said.
- Here are three ways traders can enter an uncertain market and use turbulence to their advantage.
- For more stories go to www.BusinessInsider.co.za.
The stock market has been on a wild ride so far in 2020, as it has absorbed a barrage of negative headlines since the outbreak of the Covid-19 pandemic and the ensuing economic damage.
Those negative headlines can often instill fear in investors' minds and nudge them to sell their stocks into volatility spikes, often near the lows of any given sell-off.
Instead of selling stocks into negative headline-driven volatility spikes, traders should defensively buy stocks, according to a note published by UBS on Friday.
The firm said to prepare for more negative headlines throughout the rest of 2020 due to the likely lingering of the Covid-19 pandemic, US and China trade tensions, and the 2020 US presidential election.
But don't expect the US's economic recovery to falter, UBS added.
UBS pointed to this week's jobless claims number and continued fiscal support from governments around the world as an encouraging sign for the economy, and added that there "appears to be no political appetite for renewed national lockdowns," which bodes well for the economic recovery to continue on.
UBS pointed out that "elevated volatility can have costs because it can lead to inaction, meaning investors may sit on the sidelines for longer," according to the note.
With both the economic recovery and negative headlines likely to persist, according to UBS, investors should "harness market turbulence to enter defensively" instead of "shying away from volatile markets."
Here are three ways UBS says investors can defensively enter the stock market in the midst of elevated volatility:
1. "Averaging in for risk assets."
Even though historical data suggests that it's best to commit all of your capital at once in the stock market, for investors who are sensitive to the risk of bad timing, UBS suggests dollar cost averaging. The firm recommends investors establish a set schedule to put cash to work, and to accelerate each buy if there is a 5% to 10% sell-off in the market.
This strategy can help relieve investor psychology of buyer's regret. If stocks fall, investors know they get to take advantage of it with your upcoming scheduled market buy. And if stocks rise, they at least already have part of their cash invested.
2. "Consider a put-writing strategy."
A more complex strategy to harness elevated volatility involves writing puts, according to UBS. The strategy entails an investor selling puts at a discount to the current market price. The investor collects a premium for writing the put, and two scenarios can then unfold: either the option expires worthless and the investor keeps the premium, or the market falls below the strike of the put and the investor must buy the stock at the strike price.
This strategy is ideal for an investor that is keen on buying the market at a discounted price, but still wants potential to earn money as they wait for a pull-back. Additionally, UBS said investors can take the premium collected from the put and use it to fund call options for upside exposure, in order to "reduce the potential risk of missing out on a runaway market rally."
3. "Use structured investments."
Rather than directly purchasing options, "some investors may be willing to fully commit their cash upfront in exchange for a structured investment that provides asymmetric exposure to the market, for example, levered upside participation, a degree of capital protection, or a fixed coupon payment until maturity."
"So for investors unwilling to commit all their capital at once, plenty of other strategies exist to ensure that investors do not put the chances of meeting their long-term financial goals at risk," UBS concluded.
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