Cornering the Market
On February 17, I advised my readers “Don’t Be Fooled by the Indices.” I observed that the stock market was hitting record highs despite the rising threat posed by the rapidly expanding coronavirus outbreak.
At that time, I suggested buying put options on stocks to protect against potential loss. I sure hope they took my advice. Two days later, the stock market peaked. Over the next five weeks, the S&P 500 Index fell 35%.
A month ago, I stated “The End is Nigh! (Of Panic Selling, That Is).” I noted early signs that investor sentiment was starting to shift from fear to greed. It was time to start thinking about getting back into the market.
Turns out, the day that article was published (March 23) was precisely the same day that the stock market bottomed out. Had you bought the SPDR S&P 500 ETF Trust (SPY) that day, you’d have a profit of 30% at the start of this week.
At the risk of sounding immodest, I nailed the near-term top and the bottom of this market. You may be wondering what I think will happen next. At the risk of disappointing you, I believe we’re in for several months of sideways movement.
However, that doesn’t mean that you can’t make money as an investor while that’s happening. Although the overall market may go nowhere, some individual stocks could move quite a bit.
But it does mean you have to be smart about what you do and when you do it. Passive investment strategies are out and active investment management is in.
When stock market volatility increases, so do premiums on options contracts. That’s because an option is a bet on which way, and how far, a stock price will move within a specified period of time.
Until recently, betting on the share price of a stock to move more than 10% one way or the other within the next six months was usually a losing proposition. For every Tesla (NSDQ: TSLA) that might move that far in a week, there are hundreds of companies that don’t generate nearly as much excitement.
Over the past two months, most stocks have moved much more than 10% one way AND the other. In fact, many of them have vacillated more than double that amount.
For that reason, option sellers want a lot more money to assume the risk of having to make good on a contract. The degree to which a stock is expected to move away from its current price is known as its “implied volatility.”
When implied volatility is high, as it is now, buying an option becomes more expensive. For example, a few days ago when Apple (NSDQ: AAPL) was trading near 280, I could buy a call option that expires on May 1 at a strike price of $280 for a premium of $10.
That date is important because Apple is scheduled to release its Q1 results on April 30. Depending on how those numbers turn out, AAPL could move strongly one way of the other. In this case, it would have to rise above $290 for this option to be profitable.
Turning the Tables
The stock market recovered surprisingly fast over the past month. Most stocks appear fully valued to me. Perhaps even overvalued given how little we know about the full impact the coronavirus pandemic will have on the economy. If Apple disappoints the market with its quarterly results, it could easily drop below $250 where it was trading just two weeks ago.
If that were to happen, then the option described above would expire with no intrinsic value. That means I’d lose all my money and have nothing to show for it.
However, if I owned Apple stock and sold that call option to a speculator then I’d receive that $10 premium. In that case, there are two possible outcomes:
- Apple reports great numbers and rises above $280 before expiration and my stock will be bought away from me at that price. Including the $10 option premium I collected, I would be selling AAPL for a net price of $290. I will gladly take that result in this market.
- AAPL does not rise above $280 by expiration date and I get to keep my stock. Also, I would get to keep the $10 option premium I received for writing the contract. I’d be happy with that result, too.
Normally, I’d rather buy stocks than sell call options against the stocks that I own. However, these are not normal times. Until the coronavirus pandemic is fully contained, selling options may be the smarter way to go.
Calling for Change
Over the past two months, I correctly called the top and bottom of this market. Now, I’m calling neither. I think we will be stuck in the middle for a while. What should an investor do?
Selling options is about the only way I know to make money while the stock market is stuck in neutral. And nobody does that better than my colleague, Jim Fink.
As chief investment strategist of Options for Income, Jim has made huge profits for his followers with his proprietary trading system.
Jim has developed a system that allows you to collect payments every Thursday, similar to a paycheck. Think of it as a “profit calendar.”
These payouts can range in value from $1,150 to $2,800, but average out to $1,692.50. Jim developed his strategy by studying the tried-and-true practices of Chicago pit traders and modifying them for use online.
It’s like getting an extra paycheck, week in and week out. The gain is so reliable, you can schedule it on your calendar. Jim made himself a wealthy man with his system. Now he wants to share his secrets with our readers.
Jim Fink makes money in rising or falling markets. How does he do it? Click here for his presentation.