The Illusion of Uniqueness in the Stock Market

by webmaster

Tyros and market idiots, of which there are an unlimited, replenishing number, always assert that this moment in market time is different than the past. In their view, stock prices can defy financial gravity and become unmoored from concrete facts and corporate earnings.

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The Cycle of Mass Delusions

Mass delusions have played out during many market epochs, including the birth of technology, booming housing prices, low interest rates, cryptocurrencies, the rise of artificial intelligence, and even prescription drugs that help people lose weight without exercising.

Balancing Risk and Reward

The perpetual challenge for long-term investors is balancing the risk and reward of each moment in time because only a handful of companies—and investors—seem to truly thrive over time.

Reflecting on the Present

These thoughts are worth contemplating as the stock market is once again near record highs, options volatility is unusually low, and the end of 2023 means each day brings predictions about what the new year may hold.

Will laggards be leaders? Does the decline in the 10-year Treasury note bode well for battered financial stocks? Will top technology stocks that have produced most of this year’s market gains—including Alphabet, Apple, Amazon, Microsoft, and Nvidia —do so in 2024? No one knows the answers.

The Power of Facts

The best approach to known unknowns is focusing on facts made truer by time.

Dividends accounts for about 45% to 50% of historic stock returns, and inflation adds another few percentage points. We also know the stock market rises over time, and that people always need places to deposit and borrow money, just as they need computers and technology.

A Solid Approach to Investing

A solid approach is to ignore the omnipresent market hyperbole, relax and buy blue-chip stocks of well-run companies that are critical to how people live, and that ideally pay dividends. If you do that, you will temper the risk of investing, and position yourself for long-term success if you can keep calm during chaos.

The Power of Conditional Dividends

As an investor, it’s important to explore all avenues for maximizing returns and smoothing the stock-ownership experience. One often overlooked strategy is generating “conditional dividends” through selling puts and calls. But what exactly are conditional dividends?

In exchange for receiving the options premium, which can be seen as a form of conditional dividend, investors must be willing to take certain actions. If they sell a put and the stock declines below the put strike, they must be prepared to buy the stock. On the other hand, if they sell a call and the price exceeds the strike price, they must be ready to sell the stock. Of course, there are ways to manage these positions to avoid actually buying or selling stock, but that discussion is better suited for another time.

The reason we bring up this strategy is because, amidst all the noise in the market, it’s important to remember simple and time-tested facts. While options premiums may be low due to current low implied volatility levels, don’t overlook the potential of the conditional dividend strategy. It allows long-term stock investors to get paid by the options market while holding on to their investment.

Let’s consider an example involving Bank of America (BAC). Despite a 7% decline this year, primarily due to concerns about the bank’s bond holdings, BAC remains a company that is well managed and widely held. In fact, Warren Buffet’s Berkshire Hathaway continues to be a major shareholder.

At its current price of around $30.58, investors who are interested in buying BAC stock can sell the February $28 put for approximately 59 cents. On the other hand, investors who already own BAC stock can sell the February $33 call for about 48 cents. If, at expiration, the stock is below the put strike, investors can acquire more stock. Conversely, if the stock price is above the call strike as expiration nears, investors have the flexibility to adjust the call to avoid selling their stock.

While it may seem like mundane stuff, this approach can greatly contribute to compounding returns over time. In fact, it’s a strategy that Albert Einstein once referred to as the eighth wonder of the world, highlighting its importance for long-term investing success.

Never underestimate the power of paying attention to fundamentals. It’s an approach that holds true regardless of market conditions.

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