CBOE - Using Options To Leverage Stock Sector Rotations
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There were roughly6,350 stocks listed on the Nasdaq Capital Market and the New YorkStock Exchange in the third quarter of 2022 according to Statista – and each of those stocks belongs to one of a total of just 11sectors.
The stockmarket sectors are Materials, Communication Services, Energy,Financial, Industrials, Consumer Staples, Real Estate, Technology,Consumer Discretionary, Health Care, and Utilities. These sectorsbehave cyclically, and it’s important for investors to knowthem.
Studiesconducted by the National Bureau of Economic Research (NBER) haveuncovered economic cycles and divided them into four distinct phases.These phases have been fairly consistent since 1854, and thetransition from one stage to another is typically preceded by a stockmarket phenomenon called sector rotation. Sector rotation occurs whenmoney moves from one stock sector to another.
Sector rotation can becomplicated, but the main idea is that money moves into cyclicalstocks when the economy is strong and into defensive stocks when theeconomy is weak. The Consumer Discretionary, Technology, and RealEstate sectors tend to be cyclical stocks, performing well duringstronger economic periods and poorer during recessions. Utilities,Health Care and Consumer Staples tend to be defensive stocks,experiencing moderate changes in prices, regardless of the state ofthe economy.
Cyclical stocks includecompanies in sectors where consumers make discretionary expenditures– like retailers, restaurants, luxury goods, and technology –while defensive stocks include companies that see steady demanddespite economic weakness – like healthcare, groceries, andutilities.
How To Make A Sector Rotation Play
Savvy investors can usetheir knowledge of sector rotation to help avoid losses andpotentially generate returns during shifting market cycles.
For example, assume onehad a significant position in the stock Netflix (NASDAQ: NFLX)going into 2022 and one’s analysis led one to believe that theeconomy was weakening. Replacing Netflix, a cyclical stock thatdropped 51% in 2022, with United Health Group (NYSE: UNH), adefensive stock that rose 5% in 2022, could have been a prudent moveto help prevent significant losses.
Investors regularly participate in these kinds ofmonetary migrations, but they often do it using exchange-traded funds(ETFs) rather than individual stocks. ETFs like the ConsumerStaples Select Sector SPDR Fund (NYSE: XLP) and the MaterialsSelect Sector SPDR Fund (NYSE: XLB) are two examples of popularETFs.
Making a sector rotation playcan mean liquidating stocks in a certain sector and buying stocks inanother or simply purchasing ETFs in the sector one wishes to rotateinto.
Using Options To Leverage Rotation
Cboe Global MarketsInc. (BATS: CBOE) SelectSectors Index Options provide investors with a third option:purchasing sector-wide options contracts. These options contractsallow global investors to affordably gain exposure to U.S. industrysectors while gaining potential tax advantages.
Cboe offers investorsaccess to each of the 11 stock sectors, ensuring investors have theoption to choose whichever sector they want to rotate into. Aside fromtax benefits and ease of access, investors also leverage the inherentqualities of options via this sector rotation method.
Thepicture above illustrates the efficiency of a well-executed sectorrotation. Note, for example, that as many as 7 sectors outperformedthe S&P 500 Index between Jan. 02, 2022, and Feb. 27, 2023. Withthe continuation of volatility and uncertainty, savvy investors andportfolio managers can look to sector rotation as a defense mechanismin 2023.
Helpprotect your portfolio by learning more about Cboe’s Select SectorsIndex Options here .
This article was originallypublished on Benzinga here .
This post contains sponsored advertising content. This content is forinformational purposes only and is not intended to be investingadvice.
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