Closing Out A Profitable Trade
In an article published last month (“Our Low-Risk GameStop Trade”) I detailed a strategy for profiting from the volatility in shares of GameStop (NYSE: GME). Shares opened the year under $20 and rose as high as $483 during a period of incredible volatility in January and February.
To recap the trade, at that time I explained that GME’s stock options had also taken on some irrational values. The values of some of the put options, for example, had given rise to the potential for what I viewed as a low risk trade.
Puts expiring in November with a strike price of $17.00 were trading for $6.50 a share. The premium on that put was 38% of the strike price, which is really crazy considering shares were trading above $300. My expectation was that the volatility would settle down, and the value of the put would decline under almost any scenario.
Consequently, I sold puts for $6.50/share. I indicated my intent to hold until November, when I would have realized the maximum profit on the $17.00 per share I needed to keep available in case shares were assigned. As long as shares were above $17.00 at expiration, I would have profited $6.50/$17.00, or 38.2%.
However, I also had the option to buy the puts back if the value declined.
You could have actually executed the same trade I did in the weeks after I published the article, as the puts remained around my purchase price. However, two weeks ago the share price started to climb again and the put value started to fall. When it reached $2.50, I bought them back and closed out the trade.
My rationale was that I made 61.5% ($4.00/$6.50) of the potential profit in just a few weeks, and would have had to wait another nine months to realize the full profit. On the $17.00 that I risked, I made $4.00, or 23.5% in under six weeks. Thus, I decided to take the fast money and redeploy those profits elsewhere.
I asserted at the time it was like getting money for nothing. I also promised to revisit the trade later on, but since I closed it out I wanted to document that.
You might be thinking, “That’s all well and good, but how does that help me?” The lesson here is that the trade originated from unusual volatility. That happens all the time. The reason this trade popped on my radar is, I was watching CNBC one morning and saw the huge spike in GameStop’s shares. With that kind of volatility comes potential opportunity. So I checked the option pricing, and decided that this was an unusual low risk/high reward scenario.
One way to find these opportunities is to regularly look at cash-covered put yields. For example, Fidelity has a “Strategy Ideas” page in their Options Research section. If a cash-covered put has an extremely high yield, it means that the option premium is large relative to the strike price. Those are the types of opportunities that led to this trade. That alone doesn’t make for a good trade. But it’s a starting point.
Editor’s Note: Our colleague Robert Rapier just explained a profitable options trading strategy. But we’ve only scratched the surface of our team’s expertise in options.
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