Unusual gap in stock options presents investors with big opportunity, Janus Henderson says
An unusual divide in the options market is creating an opportunity for investors to generate higher income from individual stocks, according to Janus Henderson. While volatility across the broader U.S. market appears relatively subdued, shares of individual companies have been experiencing far larger swings. “Stocks have been increasingly trading on their own stories rather than moving in lockstep. Some of the largest companies in the market have moved 10%, 15%, even 20% in a single day, often with no earnings news to explain it,” said Jeremiah Buckley, a portfolio manager at Janus Henderson. That has widened the gap between the implied volatility of individual stocks and the S & P 500, meaning investors can currently collect higher premiums by selling, or “writing,” call options on individual companies rather than on the wider index. A covered-call strategy involves selling someone else the right to buy a stock at a predetermined price. In return, the seller receives an upfront payment known as a premium. Higher expected volatility generally translates into a larger premium. The gap partly reflects the rise of thematic trading, according to Buckley. Flows into and out of single-stock exchange-traded funds, semiconductor baskets and other narrowly focused products have amplified moves in individual companies. Meanwhile, the rapid growth of covered-call and options-income strategies, many of which sell options on the S & P 500, has placed downward pressure on index volatility, making the contrast with single-stock volatility even more pronounced. Buckley said the difference gives active managers greater scope to generate income without sacrificing as much of a stock’s potential upside. For example, an investor might write fewer calls on a company trading well below its estimated fair value, allowing greater participation if its shares recover. As the stock approaches fair value and its potential gains become more limited, the investor could sell more calls to collect additional income. Because individual-stock premiums are currently richer, managers may also be able to meet their income targets by writing options against a smaller portion of the portfolio. That leaves more holdings free to appreciate. Active managers can also adjust strike prices, expiration dates and the proportion of each holding covered by options as market conditions shift. Janus Henderson said that flexibility allowed managers to reduce call writing on AI-infrastructure stocks as they rallied, while collecting premiums from defensive stocks that had moved closer to fair value. Richer premiums can also reduce the need to rely heavily on high-dividend stocks for income, according to Buckley. Managers can instead adjust the balance between option premiums, dividend yield and potential capital gains. The opportunity may be missed by systematic strategies that apply the same options overlay regardless of a company’s valuation or market conditions, he added. “In our view, single-stock volatility, not the index, is the signal that matters most for option income right now, and a uniform, index-based approach risks leaving that opportunity on the table,” Buckley wrote.
