S&P 500 to rise another 17% ?

I read this interesting article this morning. Could have a point.  LP

 

Enough with the pessimism already. Byron Wien, a senior adviser at Blackstone Group LP, says the S&P 500 could rise another 17% this year.

In his monthly commentary, Mr. Wien says an improving economy, persistent earnings growth and continue stock buybacks could propel the S&P 500 as high as 2300. It recently traded at 1982, up about 7% this year after a 30% surge in 2013 and a 13% gain in 2012.

“Very few investors see [2300] as a possibility because the market did so well in 2012 and 2013 and strong previous performance breeds caution about the future,” said Mr Wien, a vice chairman of Blackstone’s advisory services unit. “Actually, strong market performance in a given year should not discourage investors about the outlook for the following year. When the S&P 500 has been up 25% or more, the next year is usually positive….

“The U.S. market is large, liquid, transparent and, in my opinion, not overvalued,” he continued. “Stocks are attractive on a multiple basis compared to housing and bonds. I think interest rates are likely to remain low for longer than most people believe and equities may perform well for longer as well.”

Prior to joining Blackstone, Mr. Wien became widely influential as a top investment strategist at Morgan Stanley from 1985 through 2001 before taking a lower profile within the firm. He worked alongside fellow investment strategist Barton Biggs at Morgan Stanley for much of that time. Mr. Wien joined Blackstone in September 2009.

His current market views come as rising valuations have made stocks look fairly pricey. The S&P 500 is trading at 15.7 times its expected earnings for the next year, up from 15.3 at the start of the year, according to FactSet. That marks the S&P’s highest price/earnings multiple in seven years and is well above its 10-year average of 13.9.

“One of the problems limiting investor enthusiasm may be valuation,…” Mr. Wien said. “Market peaks have occurred historically at 25x–30x times earnings. On that basis, the market is fairly valued but not exceedingly expensive.”

Mr. Wien is also optimistic about the economy. “Almost every indicator I am now looking at is, in fact, showing a better tone to the economy,” he said.

With regard to geopolitical risk, he’s worried about the situation in Ukraine and the Middle East, saying there “has to be an impact on the markets from geopolitical turmoil.”

But overall, he remains optimistic that the bull market since March 2009 still has more room to run.

“I see neither a recession nor a bear market in sight even though we are five years into the economic and market recovery,” Mr. Wien says. “Let’s hope geopolitical turbulence doesn’t upset that outlook.”

High Yield Income Strategy

Please see my ‘Covered Call Writing’ post to learn how to generate monthly income in neutral markets if you currently own or wish to purchase stock and adopt this income strategy.

Similar to a covered call writing strategy , the ‘High Yield Income Strategy’ involves the writing of an out of the money call option. The difference is that, instead of writing these calls over the top of stock already owned or purchased, we purchase a deep in the money call option with a long dated expiry to ‘replicate’ a shareholding. The bought call should generally have an expiry of 9 to 12 months to negate the negative impact of time decay on the position. The bought call that is purchased should have a delta of value of 0.7 – 0.8. This means that the price of the option is generally going to move at about 70%-80% of the underlying. i.e, for every dollar the underlying stock moves, we can roughly expect this option to move 70-80 cents. This is a dynamic figure and will change according to the underlying price movements of the stock.  The benefit to this strategy compared to the conservative income strategy is that it allows for a greater potential return in terms of percentage.

To negate the detrimental nature of time value on an option, we purchase long dated calls. This will slow the time decay component of the option and allow it to hold its value for longer. We will pay more for the length of the date but in comparison to buying stock in order write calls on, we are outlaying a lot less, hence making the returns on our investment greater.

In this strategy, we replace the bought stock with bought calls as described earlier.

Example: BHP Currently trading at $30.00.

We buy one BHP JUN 2014 25.00 in the money CALL for $10.00  = Total outlay of $1000. (one contract is the equivalent of 100 shares)

We also sell 1 NOV 2013 32.00 out of the money CALL = premium of $0.50 = $50. (5.00% on initial outlay)

The stock climbs to $31.00 by the June expiry and we get to keep the $0.50 premium we received and we gain roughly 75 cents (.75 delta excluding factors such as volatility etc.) on the bought option.

If the stock falls, we will suffer a loss on the bought call option, as we would with stock but we get to keep the $0.50 premium. We then continue to write out of the money call options each month (why we chose a long dated bought call) and continue with the investment strategy.

If the stock rallies strongly, up through our sold strike of $32.00, there are two options. The first would be to take profit on the position as a reasonable profit will be unrealised. The second option is to buy back the sold $32.00 Call and ‘roll’ the option to a higher strike ($33.00) and out to July possibly. This may be done at a debit or credit depending on the option pricing but remember, the bought call position is constantly increasing at a greater rate than our sold position is costing us.

Total return on investment if stock is at $31.00 at June expiry date:

$0.75 profit on the bought option + $0.50 (premium received) = $75 + $50 = $125 for the month.

= Total return on $1000 investment of 12.5%.

We can then look to write another out of the money call option, $33.00 possibly, for the month of July and generate more premium again.

You can see that the percentage for the high return strategy far outweighs the covered call writing returns.

In comparison to covered call writing this strategy is able to generate greater returns on the basis that your initial outlay is a lot less than purchasing the stock. One option will give you exposure to 100 shares but for a fraction of the price. So when the underlying stock moves $1 on a $10.00 stock it has moved 10% but if this move occurred on a $4.00 call option, this is a 25% move.

The flexibility of options gives us the ability to constantly monitor, adapt and change our positions in relation to the underlying price movements and generate greater returns or hedge potential losses when possible.

Please contact me to discuss how this strategy can be tailored to you and your portfolio.