How to cover ‘the most catalyst-rich week of the summer’ for markets, according to BofA

For investors willing to risk getting into the equity options market, analysts at BofA Global Research have suggested there’s still time to consider exchange-traded fund strategies that could pay off in what could be a volatile week.

It’s “not too late to hedge the most catalyst-heavy week of the summer” as some options markets “still undervalue event-driven risks,” equity-linked analysts said on Tuesday. BofA, in a note on equity derivatives. “This week promises to be one of the most important this year for the markets.”

Analysts pointed to tech megacap earnings reports due out this week, the Federal Reserve’s policy decision on interest rates after the conclusion of its two-day meeting on Wednesday, U.S. growth numbers for the second quarter on Thursday and inflation indicators on Friday.

“The risk of a volatile week has not been lost in the markets,” with options markets maintaining “a significant kink” in the term structure of S&P 500 volatility for more than a month, said BofA analysts in the note. “However, we think it’s still worth having flight in all those catalysts if you know where to look.”

For example, the Energy Select Sector SPDR XLE fund,
-1.14%,
iShares China Large-Cap ETF FXI,
-0.38%,
and SPDR S&P Homebuilders ETF XHB,
-0.88%
have median returns around the last four Federal Open Market Committee meetings this year that “far outweigh the cost of an overlap expiring this Friday,” analysts said, noting that the Fed’s latest meetings did not coincide with so many other catalysts seen this week.

A straddle is a strategy of buying put and call options for the same underlying security at the same strike price and expiration date, with the put contract indicating a bearish view and the call option representing a bullish hold.

Comparing 39 exchange-traded funds across all asset classes, BofA analysts said they took into account the current “straddle” price as of Friday and the returns of the underlying asset over the past four previous weeks of the FOMC in 2022.

“If history is any guide,” they wrote, “there is still value in owning flight for this catalyst-rich week, more in equities than in credit and other more macro assets, and particularly in emerging markets, homebuilders and small caps.”

BOFA GLOBAL RESEARCH NOTE JULY 26, 2022

“But among the best-valued assets in this framework, rate-sensitive homebuilders may be the FOMC’s most direct play,” the analysts wrote. “With expectations of a slower hiking trail from here, a key risk this week is that the Fed opens the door” to further interest rate hikes of 0.75% in upcoming meetings.

Analysts suggested buying “XHB 29Jul 59.5-57.5 put spreads for $0.40 (5-to-1 max payout)”, referring to the SPDR S&P Homebuilders ETF ticker. “The risk to the trade is the loss of the initial premium paid,” according to their note.

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Many investors expect the Fed to announce on Wednesday that it is raising its benchmark rate by three-quarters of a percentage point. That’s amid fears that big rate hikes by the central bank to curb inflation could trigger a recession.

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BofA economists estimate that gross domestic product in the United States fell 1.2% in the second quarter, according to the Equity Derivatives Research Note on Tuesday.

Meanwhile, shares of retail giant Walmart Inc. WMT,
-7.78%
slipped about 8% on Tuesday afternoon after the company lowered its profit forecast, saying in a statement on Monday that high food inflation was hurting customer spending on general merchandise such as clothing.

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The U.S. stock market was down on Tuesday, with Walmart among the worst performers on the blue chip Dow Jones Industrial Average gauge and the S&P 500 index, according to FactSet data, when last checked. The Dow DJIA,
-0.73%
was down around 0.6% on Tuesday afternoon, while the S&P 500 SPX,
-1.25%
fell 1.2% and the tech-heavy Nasdaq Composite COMP
-1.97%
fell 1.9%, according to FactSet data.

Investors will be watching this week for quarterly earnings reports from Google Alphabet Inc.’s parent company, Amazon.com Inc. AMZN,
-5.06%,
Apple Inc.AAPL,
-1.08%,
The parent company of Facebook Meta Platforms Inc. META,
-4.80%
and Microsoft Corp. Google Alphabet,
-2.38%
and MicrosoftMSFT,
-3.37%
will release their results after the market closes on Tuesday.

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