Volatility is on the rise in the stock market.
The recent market action has highlighted the risk of investing in passive vehicles such as mutual funds and exchange-traded funds (ETFs).
Although these investments are often perceived as safe, the opposite has become true — putting all stock investors at risk.
With mutual fund and ETF assets increasing 88% between 2016 and 2020, a passive investment bubble has formed.
That’s because fund managers have bid up stocks regardless of the financial standing or valuations of the companies.
This is great for investors during bull markets, as heightened demand lifts stock prices. But at the first sign of danger, the bubble becomes problematic.
This Bubble Is Bad News for Most Investors
As investors buy and sell ETFs and mutual funds every day, fund managers must buy and sell stocks accordingly.
When net money flow is positive, managers buy stocks. When money flow is negative, they sell stocks.
Investors take money from these funds when the market begins falling, and the fund managers must sell stocks, amplifying price declines.
This scenario is playing out right now, and the result is a highly volatile market.
Implied volatility for the S&P 500 Index has been creeping higher for the past three years. This trend will likely continue for the foreseeable future.
The S&P 500’s Implied Volatility Has Been Creeping Higher
This is bad news for most investors. But for those that are positioned correctly, periods of high volatility can bring huge gains.
Options Shine in Volatile Markets
Buying options is one way to take advantage of periods of high volatility.
Traders can use options to gain exposure to a rising or falling market with less capital than other investment vehicles.
With less capital at stake and clearly defined risk, options shine in volatile markets since volatility can increase the reward-to-risk ratio.
Trading with a high reward-to-risk ratio provides investors with the potential for huge gains on every trade.
A great way to get started with options trading is to use my colleague Michael Carr’s One Trade strategy.
With One Trade, you trade the same ticker symbol each week, giving you the chance to target double- and triple-digit returns every time.
Analyst, Automatic Fortunes