It’s a tough market to be a buyer in with the indexes at such lofty levels, so I keep hoping for a pullback.
If you feel the same way, I’m live every Monday, Wednesday, and Friday at 11:00 AM EST to help talk you through how I play this market.
On Wednesday, I focused on a lot of the smallcap trades I’ve been doing because of a major development that’s been going on in the market of late.
Let’s talk about it…
Look, I know the market is ripping right now, making it harder to find good trade ideas.
But guess what?
There are always new opportunities popping up in the market, and this week saw small-cap stocks “take up the mantle.”
After an entire year of sideways price action, IWM (the Russell 2000 ETF) IS FINALLY BREAKING OUT!
Figure 1
Oh, and by the way, seasonally this happens to be the strongest period of the year for the Russell 2000, as shown by the seasonality chart of the Russell 2000 ETF (IWM) directly below.
Figure 2
Specifically, what this graph shows is that the IWM’s average return of +3.4% for November is the largest of any month of the year over the past 20 years. Not only that, but the number of times the month of November closed higher, is also the best.
Look guys, if small caps maintain this breakout, we’re looking at the kind of situation where these trades could continue to work, not just for a couple of days, but for several weeks to months.
Therefore, I think it’s a good time right now to start looking at some of the more beat-up smallcap stocks as potential bullish trade ideas.
One of my favorite smallcap ideas of late has been Big 5 Sporting Goods Corporation (BGFV).
According to Finviz, Big 5 Sporting Goods Corporation operates as a sporting goods retailer in the western United States. The company’s products include athletic shoes, apparel, and accessories, as well as a selection of outdoor and athletic equipment for team sports, fitness, camping, hunting, fishing, tennis, golf, and winter and summer recreation, as well as home recreation. It also provides private-label items, such as shoes, apparel, camping equipment, fishing supplies, and snow sports equipment.
The company sells private label merchandise under its own trademarks comprising Golden Bear, Harsh, Pacifica, and Rugged Exposure. As of January 3, 2021, it operated 430 stores. The company also operates an e-commerce platform under the Big 5 Sporting Goods name. Big 5 Sporting Goods Corporation was founded in 1955 and is headquartered in El Segundo, California.
Why do I like it?
First and foremost, it’s a good company.
Although we talk a lot about technical trading on a daily basis, you want to get into the habit of putting your money into good companies to lend to the conviction of your trade.
This is reflected in the fact that, for my most recent trade in this company, I sold puts with a position size of $20,000, which is double the size of the positions that I usually take when selling puts.
Another key reason I liked this trade is that, as the graphic below from Finviz shows, the stock’s got a huge short interest of almost 41%.
Figure 3
Source: Finviz
The next important item that caused me to have great interest in wanting to be bullish on this stock is the fact that there has been a huge support in the $20 to $22.50 area.
This can be seen in Figure 4 below.
Figure 4
Now, the combination of this support and the range-like action that this stock has been displaying in recent months is important because it is what I used to determine the type of trade I want to utilize to get long.
Here’s what I mean:
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I know I like the company
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I know I want to be bullish retail stocks heading into year-end
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I know the stock has been consolidating in a range above the rising 200-day moving average, which tells me that this is a correction in a longer-term uptrend.
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BUT, at the time I sold the puts to reflect my bullish opinion of the stock, I did not know when the stock would start to rise.
That right there was the indication that I want to choose an options trade that will benefit as long as the stock stays above a certain level as time passes by.
In other words, I felt confident in just entering a position that will benefit from time decay, also known as Theta decay.
If you need a better understanding of how Theta works, check out the the lesson below.
Theta
An option’s price is made up of intrinsic value and time (extrinsic) value. the closer an option gets to its expiration date, the faster that extrinsic value erodes. That rate of decay is the option’s Theta. It represents the amount of time value that will be lost in the next day.
The closer the option gets to expiration, the bigger Theta gets. And, this increase happens at an exponential rate. Here’s an example of how Theta might erode an option’s time value.
And, here’s what that would look like when plotted on a graph.
Now, whenever you buy an option (call or put), your position has a negative Theta. On the other hand, when you sell premium (call or put) you have a positive Theta. For an option buyer, Theta works against you, and for the option seller, Theta works in your favor.
Bottom Line
There’s so much to consider before choosing the right options strategy to implement.
If you have a bullish idea, perhaps the biggest question you should ask yourself is, “Do I have high conviction that the underlying stock can rally aggressively in a short period of time?”
If the answer to that is no, then maybe your first thought should not be to buy calls, but rather to either sell to open naked puts or sell to open a vertical put credit spread.
Because calls have to fight the effects of time, the price needs to move a relatively large distance in a relatively short period of time. When selling naked puts or vertical put credit spreads, however, a trader just needs price to stay above their chosen support area by the time the contracts expire and the value of those contracts declines to zero.
Remember, when we are options sellers, we want the value of the options to decline. When we are options buyers, we want the value of the options to increase.
Until next time…
