With four kids at the house, it’s made my trading more difficult and forcing me to be less active.
Just yesterday I found myself fixing a trombone!
When I do catch a few moments to look at the charts, I need a way to pick out the ones with the best chance for success.
That’s why I lean on relative strength and you should too!
I’m not talking about the indicator you can drop into your charts.
No, I’m talking about stocks that are outperforming the broad market.
For example, I used the recent strength in Netflix to smash a trade in Weekly Money Multiplier while the market couldn’t catch a break.
Trust me, being down 1% in this market is king of the mountain.
Some of the best long trades in the market recently have been relative strength plays.
If you don’t know how to find these stocks, and more importantly, how to capitalize on them—you’re in luck.
Because today’s lesson is all about how to turn relative strength into profits. And I’m going to walk you through it, step-by-step.
I want you to look at these two charts of the SPY and Kroger (KR) and tell me which one looks better.
SPY Hourly Chart
KR Hourly Chart
These two charts aren’t even headed in the same direction. Kroger clearly exhibits a bullish trend, while the SPY is melting away (which you probably already knew).
This is what I’m talking about with relative strength. You find stocks that simply work better in this market than the overall average. Sometimes they outperform by a lot, other times by just a little bit.
Take Netflix for example.
NFLX Hourly Chart
Price is in a downtrend like the SPY. However, it’s noticeably better.
First, you can see how it managed to ride above the 200-period moving average all the way through the first week of March, while the SPY broke down in late February. Second, you can see how its recent price action kept it within a range rather than sliding like the rest of the market.
Sure, there’s a story behind this stock. People are stuck at home and need entertainment. I totally get it. But, that doesn’t always have to be the case.
Check out LK Coffee (LK). This IPO is a coffee chain in China. That’s about as bad as it gets.
LK Hourly Chart
As the rest of the market broke down, this stock randomly managed to stay in a trading range for quite some time. Does that make sense? Nope. Did I make money off it? You betcha.
Now that we’ve got an idea of what they look like, let’s discuss how to find them.
I’m going to give you a few ways to find these stocks quick and dirty.
You don’t have to go through all of these scans during the day. In fact, doing it overnight is preferable since you can objectively look at them (plus your kids might be asleep).
I like to create a watchlist with the stocks. My platform has features that allow me to monitor them in real-time. However, you can always keep them in an excel spreadsheet or a notepad. Both work.
Once you have the stocks identified, look for your setups. Don’t force the trades. Let them come to you.
Over the years, I found it tough to keep with my strategy, especially in markets like these. There aren’t many trades I like, requiring way more patience. However, I learned that’s the difference between making and losing money.
I know a lot of folks struggle to find solid trades in this market. That’s why I created my LottoX service. It gives you access to my trades that get you in and out of the market in a matter of days to hours. That lets you avoid a lot of the risk holding anything too long in this market.
Check out a replay of my recent training where I explain what it is and how you not only get my trades but some great education directly from me as well.
I never used to worry about buying and selling options on the SPY, and why should I have? It’s the most liquid ETF and options available.
Fast forward to yesterday morning’s limit down, and I questioned how wide the spreads would be on the SPY put options I bought that expired on Monday.
These spreads are still wide even after an hour of the market trading!
I’m pulling out all the tricks in my magic bag, and wanted to share some of them with you in case you end up in a similar situation.
You see, extreme volatility leads to wide spreads that favor the market makers. Under normal circumstances, I would expect the SPY options to have a few pennies between the bid and the ask.
Now, it can take 30 minutes before they even come within $1.00 of one another. Even then, I’m lucky to get a fill.
So, here are 5 ways I keep the market makers in check and money in your pocket.
I’m a big fan of looking for opportunities among momentum stocks. However, this isn’t the time to go bold with thinly traded equities and even more so those with rarely traded options.
Obviously, the SPY is the gold standard for options. Mid and small-cap stocks that only have quarterly options probably aren’t good choices. Stocks like AMD, AAPL, AMZN, or any other big names work well in this market. That doesn’t mean I ignore my favorite stocks. But, I am more selective about when I trade them.
Also, pay attention to weekly vs quarterly options. Typically, weekly options are fine with decent volume behind them. In these markets, they become a lot thinner. People are gravitating more towards quarterly options at the moment. So, take this into consideration when you look to enter and exit trades.
Stocks trade way more actively than options do. Compare the number of SPY contracts that trade per day to the number of shares, and you’ll see what I mean.
If your account allows for it, you can use stock to offset your option positions. Remember, every option contract controls 100 shares of stock. So, when I wanted to offset 3 of my 5 put contracts on the SPY, I bought 300 shares of the SPY in the premarket.
You can also use futures to offset your positions in the major indices as well. However, they are prone to tighter limit restrictions. We’ve already seen them halted overnight more than once in the last few weeks.
Pro Tip – Remember that you would buy stock to offset long puts and short stock to offset long calls. However, if you’re in an IRA account or some other restricted account, you may not be able to short equities, so keep that in mind.
Some brokers offer option calculators as part of their platform. You can also build them in excel, or find free ones online. They don’t require much and can be an invaluable tool.
Option calculators can give you a theoretical price based on the time until expiration, implied volatility, current stock price, and strike prices. This may not be the price you ultimately get, but it’s a great place to start working from.
Most option platforms will give you the midpoint of the bid and the ask as your suggested price. Be VERY VERY CAREFUL! These prices are based on the current bid and ask, which can be easily manipulated.
Heck, I’ve seen it where the midprice changes based on the orders I put in!
Look at the volume on the option chain and see how many contracts have been traded. The more trades you see, the more likely it is that the midpoint will be useful. Otherwise, I’d rely on a calculator.
I’d much rather use the contract that did 17,000 trades vs 182!
Let’s say you’re ready to place your order, and you have an idea of what the option should be worth.
Here’s a step by step to try to get a fill.
This doesn’t guarantee you get a fill. But, it gives you more control over your trade. Plus, if you plan on doing multiple contracts, starting with one gives you an idea of how much additional risk you want to take on.
The best advice I can offer anyone is to be patient and wait until the moment is right. That’s when you execute your strategy.
In my upcoming webinar, I discuss how I manage my trading from developing my strategy to risk management. You’ll learn how I created my TPS system that let me turn my $38,000 account into over $2,000,000 in just two years.
Take a step back, and join me for some great education.
When an investor buys a put option, they’re hoping the value of the underlying stock decreases. They make a profit with the put when an option’s price rises, or when they exercise the option to purchase the stock at a price that’s less than the strike price. They are then able to sell the equity in the open market, the difference of which is all profit. By purchasing a put option, they limit their loss risk to only the premium paid for the put option.
Key takeaways to buying a put option
Put options let investors establish a bearish position on an index or security. When an investor purchases a put option, they buy the right to sell the underlying asset at the option’s stated price but are under no obligation to buy the secured asset.
The investor must exercise the put option within the contract’s specified timeframe. If the value of the asset falls below the put strike price, the put value appreciates. Conversely, if the value of the asset remains above the strike price, the investor won’t need to purchase the asset, and the put can expire worthlessly.
Put options are especially useful for hedging the risk of declines in stock or portfolio since the worst-case scenario is losing the put premium, or the price an investor pays for the option. This happens when the drop the investor was anticipating doesn’t happen. However, even in this case, the increase in the portfolio or stock may offset a portion or all of the premium paid for the put.
Most exchanges offer a wide range of put options with various expiration months and strike prices. This allows investors to pick a put option that meets their objectives. Factors to consider when deciding which put options to purchase include:
If an investor expects an asset to finish its downward movement within two weeks, they will want to purchase a put with a minimum of two weeks remaining on it. Generally, investors don’t want options with six to nine months left if they only plan on being in the trade for a couple of weeks as the option will likely be more expensive.
Investors need to be aware that the time premium of an option, or the value of the option based on how much time remains before expiring, decays more quickly in the options last 30 days. This means they may be right about a trade, but the option may lose too much time value for them to be profitable in the end. Investors should only buy options with more than 30 days left until expiration.
The majority of futures exchanges offer a wide range of options with various expiration months and strike prices, allowing them to select an option that meets their specific goals.
Depending on an investor’s risk tolerance and account size, some options may be too expensive for them to purchase. In-the-money put options and options with more time remaining before expiration are more costly than out-of-the-money options with shorter expiration time periods.
Unlike futures contracts, there’s no margin when buying futures options. This means investors need to pay the entire premium upfront, so options on volatile markets such as crude oil futures will most likely cost an investor several thousand dollars. Transactions such as these may not be suitable for all investors. It’s important for investors not to buy deep out-of-the-money options just because they can afford to. Most experts consider these options long shots with most deep out-of-the-money options expiring worthless.
To control their risk and maximize their leverage, investors need to have an idea of what kind of move they anticipate from the futures or commodity market. Buying in-the-money options is a more conservative approach, while buying in-the-money options a more aggressive one. If a market makes a significant downward move, having several out-of-the-money options contracts increases an investor’s returns. The risk is also higher, though, with them taking a chance on losing the whole premium if the market doesn’t go down.
When an investor decides to jump into the world of buying put options, they’ll discover the process is quite easier than shorting stock. Buying a put option is much cheaper, offers more leverage, and doesn’t require them borrowing shares of an asset to initiate their position.
Investors need to identify the asset they think will decrease in value. Let’s say an investor thinks Starbucks Corporation (Nasdaq: SBUX) will decrease in value in the next month.
Since put options have expiration dates, investors need to decide how much time they want to buy. This decision is based on how long they plan on being in this position. Instead of just purchasing a one-month put option for SBUX, they should buy an additional month or two. It’s always safer to have more time than needed than not enough. Buying long-term options also limits the effect of time decay.
Finally, investors need to select a strike price. In-the-money put options are more conservative, making them an excellent place to start, especially for new investors. In-the-money puts have a strike price higher than the stock price. With SBUX sitting at $88, an investor could buy a two month $90 put for $2.70. Since put prices are on a per-share basis, the $90 put would cost a total of $270 ($2.70 x 100 shares). This price is also the maximum risk in this position.
Put option rewards are only limited by the underlying stock falling to a zero value. Just like with trading stocks, the objective with put options is to buy low and sell high. If SBUX takes a big enough drop, it could send the $2.70 put option to $4, $5, $6, or higher.
After the SBUX stock has made an anticipated drop, the investor can exit the put option, hopefully with profits in tow.
Put options allow investors to meet specific objectives and play the market in ways they may not otherwise be able to. While other strategies like futures contracts and short selling offer similar outcomes, there are definite differences that investors need to be aware of.
Unlike put options where an investor’s total loss risk is limited to the premium they paid for the option along with any additional fees, futures contracts have unlimited loss potential. Futures contracts also move in value more quickly than put options, unless the put option is deep-in-the-money. The increase in volatility makes it harder for an investor to ride out many of the ups and downs, forcing them to close the contract early to limit their risk.
Both put options and short selling are bearish strategies investors use to speculate on an asset’s potential decline. They can also assist in hedging downside risk in a specific stock or portfolio.
Investors who short sell are basically selling assets they don’t have in their portfolio. They do this believing the underlying asset will decrease in value in the future. Investors purchasing put options are also betting the cost of an asset will decline in the future and state a price and timeframe they will sell that asset at.
Experienced investors look at many factors when deciding between short selling and buying put options, including if the trade is for hedging or speculation, cash availability, risk tolerance, and investment knowledge.
While buying put options and options trading can be very lucrative, they also carry risks that investors need to be aware of. Jeff William’s free Profit Prism Small Account Starter Pack gives investors the tools needed to understand investment strategies and grow their accounts.