It’s a Wonderful Market—if You Know How to Play It

Traders at the New York Stock Exchange on Dec. 22. (Michael Nagle/Bloomberg)

Investors are starring in Wall Street’s version of It’s a Wonderful Life, and most don’t even know it.

Despite recent temper tantrums staged by market-leading stocks, and the fearmongering neurosis of the chattering class, the S&P 500 index is still near record highs.

Options volatility suggests that trading will be uneventful for the remainder of the holiday season and into the new year.

Unlike the classic movie, though, Wall Street has no angels to help those who, like the film’s hero, George Bailey, have lost their way through bad luck or faulty decisions. But fret not. The path to investment success is easy to find because it’s well trodden and simple.

All anyone needs to do is to remember that stocks rise over time. The advance is sometimes serpentine, which is why market volatility should be considered something to monetize—or mostly ignore.

For a nuanced view of the stock market’s mental and structural health, look toward the Cboe Volatility Index, or VIX, which synthesizes sophisticated investor concerns into a number that reveals greed and fear.

The VIX is currently around 14, suggesting the S&P 500 will move less than 1% each day over the next 30 days. The VIX futures curve indicates a more cautious outlook, but nothing unusual.

The VIX’s long-term average is about 19, so the present level suggests peace in markets and goodwill toward investors. At least for a month.

If there were fear of a major correction, the VIX complex would almost certainly be higher. It’s true that options-selling strategies suppress volatility, but nothing now indicates that the market mob will soon head to a dive bar, as did a battered George Bailey, when he numbed his nerves before jumping from a perfectly good bridge into a freezing river.

Just in case our optimism proves to be misplaced—the Jan. 28 conclusion of the Federal Reserve’s interest-rate setting committee could interfere if interest rates aren’t lowered—you should have a plan.

When George was depressed and suicidal because his savings and loan was insolvent, he was helped by an angel—and his wife. She asked friends for help in a GoFundMe-like plea. The angel showed him the impact he made on the world. Everyone contributed what money they could to save George’s business from Mr. Potter, an unsentimental tycoon who makes the toughest takeover bankers and lawyers seem like sissies.

We have long counseled investors that volatility is a friend that can be used to buy stocks lower, sell them higher, or to generate conditional dividends.

When favored stocks decline, sell put options just below the stock price and that expire in a month or so to buy stocks when they are weak. This monetizes Warren Buffett’s advice to be greedy when others are fearful.

If the stock is above the put price at expiration, investors keep the money received for selling the option. When that happens, investors collect a “conditional dividend,” which is a phrase we coined to describe the payout that investors get for agreeing on the condition to buy stock at a lower price, or to sell at a higher price if call options were sold. (Puts give holders the right to sell an underlying asset at a designated price and time; calls give holders the right to buy an asset.)

Common-stock dividends represent 45% to 50% of historical stock returns, so conditional dividends are a critically important way to enhance investment returns. Too few people understand that fact.

If you heed our words, you will avoid the pitfalls that ensnare many others. You won’t always win, at least not in the short term, but you will have a functional long-term plan that can be continually refined in pursuit of a wonderful life.

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