We live in a brand new world, ladies and gentlemen.
Yes, things are different now and everyone can feel it. The Dow Jones Average has officially passed 20,000.
For traders who deal in stocks and bonds, this generally means good things. A rising Dow means greater wealth all around, albeit not necessarily unambiguously. (There will still always be some losses.)
For options traders, things are a little bit murkier
Here are three things to consider about how a 20,000 Dow might affect options trading.
1. Ignore it
Sorry to burst any bubbles out there, but up front, it’s important to note that stock market milestones have very little effect on the real world.
This is a surprisingly important point.
Major benchmarks, like the Dow hitting 20,000, can have an emotional impact substantially outsized to their financial importance. As a result, feeling like this is a sign of a strong bull market, for example, people will often make decisions around them.
Taking some chances on the market isn’t necessarily a bad thing, but don’t read too much into it or change your long-term strategies. Jumping into a series of investments based on Dow 20,000 won’t do your portfolio much good because, in the long run, that just doesn’t mean all that much.
2. Consider financial options
As we’ve covered in the past, derivatives can cover far more than commodities, including contracts, financial instruments and stocks.
That’s pretty relevant here, given that Dow 20,000 has been particularly spurred by gains in the financial sector, largely due to expected increases in the Federal Reserve interest rate.
As a result, investors looking to plan around this growth could certainly do worse than considering options related to the financial industry.
3. Focus on over/under performers
Right now may be the right time to focus on companies that haven’t quite caught up with the overall market. Since the Dow Jones Average is calculated based on only 30 stocks, contrary to popular belief, many other prices will take some time to catch up to major benchmarks.
So take advantage of the moment and start looking at call options on stocks that seem to be substantially trailing the rest of the market.
Too, keep an eye out for investments that seem to be overinflated. As noted above, one of the hallmarks of a benchmark moment like Dow 20,000 is the emotional impact. People can get over-excited and jump too far, too fast into an investment.
As a result, now may be an ironically good time to consider put options on some of the big leaders that seem to have surged ahead in recent weeks. They may be due for a correction.
Major benchmarks in the stock market are interesting, and it’s certainly better to have the Dow Jones Average go up than down. That said the most important takeaway from Dow 20,000 for the options investor is this: Don’t read too much into it.
The stock market trends upwards, that’s what a growing economy does. This isn’t a time to change any of your long term investment strategies, nor is it a time to make big moves based on a nice, round number.
That said, if you have some risk capital laying around, finance and lag should be worth keeping an eye on.