How to play market volatility in 2023, according to Evercore ISI

Published Wed, Dec 28 202210:48 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Evercore ISI says there could be big swings in the market early next year, so investors may want to use an options strategy to help cushion the impact. "There's never been a bear market that has bottomed without a noticeable volatility spike, and that didn't occur at all in 2022. That's why we think the first half is likely to be volatile," said Julian Emanuel, senior managing director at Evercore ISI. "There's never been a bear market that's bottomed before the recession started, which is why we think the October bottom is a bottom, not the bottom," Emanuel said. Evercore ISI expects a shallow recession in the second half of 2023. The CBOE Volatility Index , or the VIX, ended Wednesday at about 22. This so-called "fear gauge" for Wall Street is based on puts and calls traded on the S & P 500. "Frankly, with the VIX down here near 20, we're telling people to go long option convexity type strategies," Emanuel said. Breaking down the options strategy A put option gives the holder the right to sell an asset at a stated price, known as the strike price. When the current value of the asset is higher than the strike price on the put option, then the option is "out of the money." Meanwhile, a call option gives the owner the right to buy an asset at a given strike price. When the value of the underlying asset is trading below the strike price, then the call is "out of the money." Emanuel's strategy involves buying March 31 S & P 500 puts and calls that are out of the money. He said that since the October low, the index has been in a range that's bound between 3,500 and 4,100. "We're telling people to buy 4,100 calls and 3,500 puts on the idea that in all likelihood, you are going to break out of that range in that time," he said. "But even if you don't, there's going to be enough volatility to support the idea that the psychology could change, such that the range will give way." By purchasing calls at 4,100 and puts at 3,500, investors can benefit from sharp swings – whether they're up or down – in the first quarter. Emanuel said there's a reasonable probability the range could be broken. "Because of the unknowns out there and the range of outcomes to those unknowns, the market could break the range that it's been in in the last number of months," he said. "Even if it doesn't, we think there's going to be a sufficient amount of uncertainty and volatility to warrant the VIX moving higher from this current level of around 20, which will make those strategies profitable." "It all comes down to the fact that if you look at the last year, every time the VIX trades down to 20, you have another volatility spike," Emanuel said.