Liz Looks at: Opposing Trades

By: Liz Young Thomas · July 20, 2023 · Reading Time: 7 minutes

This or That?

That’s how the lyrics of a 1991 hip hop song called, “The Choice is Yours” start off — and although the rest of the song has no relation to investing, the words frame this blog post perfectly. Apropos of absolutely nothing, the 90s still hold the gold medal for the best hip hop ever made, IMO.

In any event, I thought I’d take a detour from my typical macro-driven blog posts and write one that aligns more with executable trade ideas. But these trade ideas are all a choice of either-or, with each option diametrically opposed to the other.

Why take this approach? Partially because it seems to fit the tone of today’s market and the pressure to choose sides. Partially because comparisons of opposing assets are a way to use the “tape” as our guide, without getting too locked in on one set of securities that simply proves our own point (aka, confirmation bias). And partially because it exaggerates the point, only to prove that exaggeration is actually the enemy.

So let’s explore some choices in the land of “this or that?”

My Fear or Your Fortune?

The first choice is between puts or calls on the S&P 500, with puts representing those who are betting that the market will fall (i.e., purchasing downside protection, or the option to sell at a certain price), and calls representing those who are betting the market will rise (purchasing the option to buy at a certain price).

We start by looking at current market conditions using the Credit Suisse Fear Barometer as our guide. The price of puts and calls works like any other asset—the more demand there is, the more the price rises, and vice versa. This index measures them together, by taking the cost of puts (downside protection) relative to the cost of out-of-the-money calls (upside expectation). The result is a measure of how much people have to pay for protection at any given moment.

Naturally, the higher the cost of protection, the more “fear” is embedded in the market.

The cost of protection has been on a steady increase for most of 2023, with the most recent months in a range of what I’ll call “medium-high to high,” and marking the most demand for puts since early 2022, when the S&P hit its cycle peak.

The question I’ll come back to then is, this or that? Puts or calls? On one hand, puts are pricey and calls are cheap. Valuations alone would tell you there’s less risk in calls. But options aren’t just about valuations, they’re about getting the direction right, or at least allowing you to sleep at night.

At these levels, and judging by what usually happened on this chart after a spike in “fear,” I’d choose puts here even though they cost more. But that doesn’t make me right and call buyers wrong. It’s simply a choice given my expectations.

That’s what markets are, after all. A collection of investor choices on any given day, and in order for markets to function, those choices are often in opposition to one another. Let’s keep going.

New Age or Old Hat?

This trade choice is about as diametrically opposed as it gets in today’s market. Technology stocks or Treasury bonds?

It’s no secret that Tech stocks have staged a major comeback so far in 2023, with the Nasdaq 100 up over 45% YTD. Treasurys (as measured by the 10-year yield, inverted below) have been more volatile and are actually down 0.2% YTD, while seeing three swings of 70-75 basis points in yield so far this year. Regardless, tech stocks climbed higher in an almost perfectly straight line.

Since rising yields mean falling prices, we’ve inverted the Treasury yield on this chart to illustrate a corresponding drop in value of the security.

I ask the question again, this or that? Tech or Treasurys? Much like the previous comparison, this decision is ultimately a reflection of an investor’s opinion on market direction. Tech may have more room to run up, that’s the beauty of stocks — they have no upper limit. Similarly, Treasurys may have more room to fall — especially if the Fed becomes more hawkish or inflation proves more stubborn.

There is no right or wrong, only opinions. My opinion from looking at this chart is that each line has seen a meaningful move, and one that appears extreme compared to the last 5+ years. In that case, I’d choose the trade that looks closer to the bottom of its range than the top — and for me, Treasurys it is.

Shine Like Gold or Lead Like Washington?

Last, but certainly not least, is the choice between the US dollar and Gold. This one is, perhaps, the most difficult to choose between by simply looking at a chart and trying to discern a takeaway, but it’s not for lack of trying (believe me, I tried).

The conversation lately has been more dollar-centric as the Fed nears the end of its tightening cycle and the dollar has lost value by the pure nature of interest rate expectations and differentials around the globe.

Gold, on the other hand, has seen a nice rise this year…but that rise is impossible to detach from the fall in the dollar since these tend to move at least loosely, in opposite directions.

We tried to distinguish a clear direction in either by looking at historical tightening and easing cycles. Unfortunately, any determination I would try to make based on that would be unconvincing at best.

Which means we’re left with a choice that may need to be made based more on theory than recent price moves. And theories are just that…theoretical. But in any event, we still must choose for purposes of this game I’ve forced us into.

Currencies are one of the trickiest asset classes to analyze, because they’re affected by so many moving pieces at once. Not the least of which is what every other country is doing with theirs. One of the most important drivers, however, is the corresponding country’s level and direction of interest rates. Since we are quite confident that the Fed is nearing the end of its hiking cycle, the direction of rates in the US is likely to be interpreted by markets as sideways-to-down over the next 12 months. As such, the US dollar has fallen for a reason, and it would seem even more reasonable for it to remain at these levels or fall further.

On the contrary, to the extent that investors still view Gold as a store of value, it has, and could continue to, benefit from a weaker dollar, elevated global inflation, and an uncertain path for crypto assets.

If I were making a pros and cons list, Gold wins this one. But to be clear, in the case of an economic downturn, both of these assets may experience an upward bump.

Eeny, Meeny, Miny, Moe

Markets are made of choices, not teams. Opinions, not face-offs. Although this post outlines choices between three sets of options that are seen as opposites in many investors’ eyes, the main point at the end is that it doesn’t always have to be one or the other and a zero-sum game.

I’ve outlined which trades I would favor in each of these scenarios, but that doesn’t mean I can’t own both. There is a difference between being overweight and underweight, vs. being all-in or all-out. In this environment perhaps more than most, the nuanced gray area is where investors may come out best in the end. Don’t we all have the same goal anyway? To make money. With that in mind, everyone is actually on the same team.


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