2016 stock market forecast and stock option strategy: Crash or flat, that is the question

As the last article discussed the overall view of the financial markets in 2016, this article aims to specifically discuss the stock market.

We have insisted the easy market fuelled by the QE is already over, and the stock market will face difficulties and uncertainties. The following three remarks conclude our general forecast for the US stock market:

  • The upside is limited due to rate hikes and the strong dollar
  • A sudden plunge can always happen, presumably by 10-30%
  • It still take a while till the total collapse of the QE bubble

In such a situation, mere buying or selling cannot be profitable. Both of short selling and the long-short strategy have some flaws. Then what can we do? After long contemplation, our conclusion is as below.

Selling put options on stocks and short selling S&P 500

We understand most of the investors would just buy or sell stocks, but we would like to convince you that option trading is crucially necessary for 2016. This is a situation where we cannot expect normal capital gains. A famous bond investor Mr Bill Gross suggested an even more complex strategy.

Then, what should we do? Here is an example. The writer has been selling a put option of Micron Technology (NASDAQ:MU; Google Finance), expecting that until its next financial release, the stock price will not go below $14.5, or if it does, it will rebound eventually.


Selling put options

With that prediction what can we do? A put option is a right to sell a stock at a certain price at a certain day, and if you sell a put option, and the stock price does not go below the decided price by the day, you will earn a premium. For details please read the following article:

This prediction has been right for a couple of months, and therefore the writer is gaining a premium of averagely 1.5% of the stock price per week, even though the stock price has not been going up or down.

This is how we gain a profit in a market that would not go up. However, as we declared at the beginning, there always is a risk of the stock market to suddenly plunge without a reason. That is why we also short sell S&P 500.

However, this kind of strategy completely ignores the possibility of the stock market going up. Will it not go up? We assume it will not. Here is the reason.

Why will the US stocks not go up

The reason is not directly the Fed’s rate hikes. A single rate hike by 0.25% would not hurt the US economy. However, unlike the European and Japanese stocks, the US stocks are no longer supported by the quantitative easing, and in addition the strong dollar has been hurting the profit of exporters.

Therefore, the market will proceed whilst stock investors continue to fear the possibility of a crash of the QE bubble. This is why the stock market has been very volatile.

However, the time for a total collapse has not yet come. The QE bubble would not burst as long as the long-term interest rates of the US remain low. As explained in the article above, with low interest rates stock investors would not try to sell stocks to buy bonds.

Yet, will the US bond yields remain low? We assume they will as the European bonds are supported by the QE by the ECB (European Central Bank). The US bonds cannot be too much more depreciated than, for instance, the Spanish bonds.

The difficult year

2016 will be a difficult year. Please compare our strategy to Mr Bill Gross’s strategy. It would sound complex, but then you will know how difficult good investors consider 2016 is.