The current market conditions have created a lot of uncertainty for traders. Many are wondering if now is the time to buy stocks, or if they should wait for the market to rebound. In this video, we will explore stock options trading in a recession and how you can make money regardless of which way the market moves!
We will discuss:
- What is coming for the market in the year ahead?
- How long will the recession last? (Is the recession cyclical or secular?)
- What options strategies are best during a recession?
- Picking levels to put cash to work long
- What is the ultimate plan going forward?
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If you are interested in learning more about stock options, please shoot me an email at darren@darrensteves.com and we can book a FREE 15-minute video call. We can talk about your goals and if you may be a good fit for the options coaching program.
So let’s get started!
What is coming for the market in the year ahead?
Stocks are down 24% from the January peak of 4800 as of the date of this video. This is because we are entering a recession. For the 3rd straight time, the Fed has consecutively raised rates to 3.25%. The market is expecting the Fed to continue to raise another 1.5%. Think what that will do to the market and the economy. Chairman Powell is starting to talk about a recession and the economic pain it will cost to bring inflation down. As well as the jobs that will be lost. He is working to bring the unemployment rate from 3.7% up to 4.4% to curb inflation. The Fed needs to get a weaker jobs market and weaker spending to bring down inflation because of the rate increases.
Utilities will continue to go up. Savings are running out and near the end of this year discretionary spending should start to slow down. Stocks will fall a lot further when that happens.
Europe will see a huge energy crunch with prices rising higher. They are already hurting.
We have already had 2 quarters of negative earnings growth so we are technically in a recession now. The market is hoping that there will be a soft landing which will not happen. 1.5M jobs will be lost to curb inflation. The market needs to realize that.
We still have good earnings growth. However, the high-interest rates and strong dollar will hold back and hurt earnings. When we have to convert to US currency with historic strength it lowers earnings.
Factset Earnings Insights (free resource) shows $226 as the earnings for all the companies in the S&P 500 for this year in 2022. This should be very close to where we will end up. If you look at next year at 2023, analysts are still expecting companies to report $243 which is 7% above where we are today. This is delusional and there is no way in hell that this will be done with a recession!
I’m estimating we should end next year closer to $200 vs the $243.
During a recession, corporate profits fall off a cliff. People aren’t spending and there is typically a 10-20% drop in corporate earnings.
Analysts and the market are holding out hope that there will be some sort of soft landing and we will not get a recession. That is not going to happen.
How long will the recession last? (Is the recession cyclical or secular?)
Will this be a secular long-term bear market like the .COM crash in 2000s? Or a normal cyclical bear market that lasts 18 months to a couple of years? A secular bear market is categorized by below-average stock market returns throughout nearly a generation, while a cyclical bear market’s average length approximates that of a 2-3 year business cycle.
I think we are entering a normal cyclical bear market that will last somewhere around 18 months to a couple of years. Then we may start coming out of it sometime around the beginning of 2024. However, no one can predict it and there are so many variables.
The productivity and improvements are just too good with a new era in innovations to stay down too long. We have AI and robotics and new technologies that will drive stock prices higher.
What options strategies are best during a recession?
Short strategies betting that the market will go down are the best when entering a recession that is just starting. Normally implied volatility is high as the market moves down. In high volitility, it is best to sell premium versus buying premium. So I like selling calls and call vertical spreads. The chances that a stock will sky-rocket up is low.
Once the market has taken a hit and prices have dropped, I like selling strangles and iron condors. This is because we make money on both sides and can adjust small moves up or down and still be profitable. Since the market has already fallen big there is not much more room to fall unless it is going to zero and out of business. At some point, the PE ratios are so low that they just don’t go down more.
At some point, we may likely hit a level where everything is priced in and fear has reached a high. This is when we are at a multi-year low. Now is the time that I want to get long. I sell more puts and put vertical spreads at this time.
What is the ultimate plan going forward?
Rather than be reactionary, I like to have a plan when entering into a recession. I have picked 3 different levels where I want to deploy different amounts of cash and invest in bearish, neutral and bullish strategies.
With SPY at 3500, stocks are down 27-30% from the 12 month highs. At this level, I think we still have further to drop. So I am invested mostly in neutral and short positions. I want to be about 70% invested with 25% short, 35% neutral and 10% long positions.
At 3200 and stocks down 35% from the peak, we are at the level we fell to in the March, 2020 stock market pandemic crash. I want to be a little more invested at about 80% with more neutral and long positions.
If and when we hit 3000 and stocks are down 37%, I want to be mostly long. This is at about 15X price to earnings expectations for 2022. Anytime we hit 15X PE that is a good time to be in the market historically.
Once all the worst news is baked into stocks then the market can move up. Below is the plan for the mix of strategies and amount of cash I will invest at those levels.
Current mix with S&P above 3500 – 70% invested
Short – 25%
Neutral – 35%
Long – 10%
If and when the S&P hits 3200 – 80% invested
Short – 10%
Neutral – 40%
Long – 30%
If and when the S&P hits 3000 – 90% invested
Short – 0%
Neutral – 40%
Long – 50%
I generally like to have a mix of ETF’s and individual stocks in my trading portfolio. I will trade the popular ETF’s like QQQ, SPY, XLP, XLV and a few others.
The individual stocks that I trade are normally the popular liquid stocks that most people know. I typically try to just keep it to my top 10 best opportunities and then increase the number of contracts from there rather than add additional stocks. I like to look at the fundamentals and know why those stocks are moving or not moving. It is hard to do that with more than about 10.
Once we are back to the normal S&P historical trend line, I will readjust to my ideal levels of investment for my options trading account.
When will the stock market recover?
I expect we will be down in the 3000-3500 territory for a year to 18 months, and then begin to move up past the 3500 level sometime in 2024. At this time I will start to invest more into the best tech stocks that will fuel innovation and growth going forward.
Key Takeaway
If you take away one thing from this video, make it a plan. Have an idea of where you want to be invested at different levels. That way you are not just buying things because they are going down, but because they fit into your investing thesis and strategy.
Thanks for watching! I hope this helped you better understand how to trade options during a recession. Please remember to comment below, hit the thumbs up, and subscribe so you will be notified of more videos like this. In the next video, we discuss the specific stocks and sectors that will do well in a recession as well as coming out of a recession.
Also, shoot me an email at darren@darrensteves.com if you are interested in the coaching program.
Happy Trading!