Reuters/Jonathan Ernst
- The constant ebb and flow of news on the US-China trade war has rocked global markets and left investors uncertain about what happens next.
- JPMorgan’s quantitative strategists offered four trades that should help investors navigate the ongoing volatility and profit, regardless of how the dispute is resolved.
- Click here for more BI Prime stories.
If you’re an investor who is suffering whiplash induced by the trade war, you are not alone.
The wild roller coaster of statements, tweets, and TV hits from politicians representing the world’s largest economies has taken its toll on global markets in recent weeks.
The good news, according to a team of JPMorgan quantitative strategists, is that the stock market’s performance is more likely to improve than worsen in the short term. But even if their bullish view doesn’t pan out as expected, they’ve provided clients with trading ideas that could work in either scenario.
To understand why they’re bullish on the stock market’s next move, consider that they’re focusing on the technical drivers of recent volatility, not the fundamentals like recession risk.
Rather than pointing fingers solely at trade-related risks, they’re examining the algos — specifically programmatic trading in index options — and how they exacerbate sell-offs.
Their role was vividly at play on August 14, when the major indexes plunged by as much as 4%, according to Marko Kolanovic, JPMorgan’s global head of macro quant and derivative strategy. He estimated that roughly half of the $75 billion in programmatic outflows on that day stemmed from strategies that are used to automatically reduce investors’ exposure to risk during a sell-off.
The upshot is that these strategies have left systematic investors lightly positioned in stocks and primed to reload once the conditions are ripe.
Kolanovic also noted that the concurrent sell-off in equities and rally in bonds changed the asset mix for pension funds that allocate a fixed weight to each asset class. Needing to rebalance, these large investors could soon dive back into the stock market and propel it higher.
"Given that equities further underperformed last week, our model now suggests these rebalances could drive ~2.5% outperformance for equities this week," Kolanovic said in a recent note to clients.
Options trades to profit from a rally or hedge losses
However, the reality is that a presidential tweet or a statement from China’s Ministry of Finance could be the first domino that sets off a market move in either direction. Kolanovic is well aware of this, and is not leaving clients in the lurch in case markets head further south from here.
"With Phase III tariffs coming full-circle and the path of negotiations remaining uncertain, we once again highlight limited-loss trades which we view as having favorable risk-reward to position for either an improvement or further deterioration in trade," he said.
His recommendations to profit from a rally on positive trade news are:
1. Buy S&P 500 out-of-the-money calls to play a market rebound given light investor positioning and steep call wing skew.
2.Buy calls on stocks and sector ETFs hardest hit by trade escalation to play an easing of tensions.
3. Buy puts on (so far resilient) stocks most exposed to the 12/15 tariff list.
And to hedge against a sell-off:
4. Buy best-of puts on a basket of S&P 500, FXI and Euro STOXX 50 as a tail hedge for a sharp deterioration in trade.
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See Also:
- A $60 billion investing firm unveils 7-year forecasts for a wide range of assets — and explains why emerging markets are a trader’s best bet
- GOLDMAN SACHS: Recession fever has put hedge funds’ most beloved stock trades in the crosshairs of disaster. Here’s how to safeguard yourself from big losses.
- Denise Shull made a name for herself training Wall Street’s top investors to perform better through psychoanalysis and neuroscience. Here are her top tips for traders.
Source: Business Insider – aoyedele@businessinsider.com (Akin Oyedele)