After a record-setting rally to start 2020, it seems stocks finally flew a little too close to the sun.
The Dow Jones Industrial Average (DJI) is just off its worst day since October, and gave back all of its year-to-date gains.
The spreading coronavirus has thrown a wrench into many Lunar New Year plans in China, and with confirmed cases popping up around the globe, travel and oil stocks have been among those hardest-hit by the recent sell-off.
Now, don’t get me wrong — the coronavirus is unnerving.
But guess what?
Past epidemics have been buying opportunities.
While the recent stock market retreat has many “vanilla” bulls running scared, my paid Weekly Windfalls members are JUMPING FOR JOY!
It’s basically Fear Factor: Jason Bond Edition, but instead of eating spiders or jumping out a helicopter for a prize, I’m cashing checks in my RagingBull hoodie at home.
That’s because FEAR = JUICY OPTION PREMIUMS.
So as option sellers, this roller-coaster market means we can make a MINT, guys and gals.
In fact, when most traders were running for the hills yesterday, I made four figures in JUST A COUPLE HOURS.
And today I’d like to show you how.
How Options Get Priced
First, a refresher on option prices.
See, option prices are comprised of two things: intrinsic and extrinsic value.
Not all options have intrinsic value — only contracts that are in the money (ITM):
- A call option is ITM when the stock is trading above the strike
- A put option is ITM when the stock is trading below the strike
Specifically, intrinsic value is merely the difference between the stock’s price and the ITM option strike.
So, a call option that is 5 points ITM (so a 100-strike call when the shares are at $105) has $5 in intrinsic value.
A put option that’s 5 points ITM (so a 100-strike put when the shares are at $95) also has $5 in intrinsic value.
When an option expires, it is worth ONLY its intrinsic value.
On the other hand, all options — ITM, at-the-money (ATM), and out-of-the-money (OTM) — can have extrinsic value.
And as a reminder:
- An option is ATM when the strike is at or near the stock price (100-strike call or put vs. $100 stock)
- A call is OTM when the stock is trading below the strike price (100-strike call vs. $95 stock)
- A put is OTM when the stock is trading above the strike price (100-strike put vs. $105 stock)
Extrinsic value is mostly comprised of time value. The longer an option has until expiration, the more time value it has (meaning it’s more expensive).
That’s because the longer an option has until expiration, the more time the stock has to make a big move and push the contract into the money.
The rest of extrinsic value is mostly made up of implied volatility (IV), or how much volatility the options market expects for the shares.
And THIS, ladies and gents, is why option sellers like me are champing at the bit about the recent market turbulence.
Volatility & The Fear Factor
What is implied volatility?
Well, you can almost deduce it by its name: implied, meaning suggested or assumed; and volatility, meaning the ability to change rapidly and unpredictably.
Therefore, implied volatility is essentially the option market’s prediction for stock volatility.
Kind of like how Vegas oddsmakers might determine the spread for the Super Bowl. Will it be a high-scoring battle of offenses, or a boring “defenses win championships” kind of game?
The higher the IV, the more expensive an option will be.
That’s because, sticking to our Super Bowl analogy, a high-octane offense is more likely to cover a spread, right?
It’s the same with options… A stock that makes big moves is more likely to “cover the spread,” so to speak.
Think about it…
Say there are two stocks, both trading around $100.
The only difference is one of the stocks is expected to make a big swing, and the other is expected to snooze around the century mark.
Which stock’s options will be more expensive?
It’s the more volatile stock, of course, because that one gives you better odds of your option moving ITM by expiration day.
So, what pushes IV higher?
Well, there are a few things, including:
- Earnings. Quarterly earnings reports often send stocks gapping way higher or lower in a single day. They’re potential volatility catalysts, and naturally that stock’s options will have higher IV heading into the release.
- Other events on the calendar — like the FDA-related trades my mentee Kyle Dennis has been crushing lately — can also push IV higher.
- And finally, BROAD-MARKET FEAR. Like what we’re seeing now. When fear prevails on Wall Street, IVs in general tend to climb a hill of “anxiety premium,” because stocks are going haywire and making bigger-than-usual moves.
What It Means for Option Sellers
Guys and gals — OPTION SELLERS WANT TO CAPITALIZE ON HIGH IV.
As with anything you sell — vintage records, options, your firstborn child — you want to get as much money as you can, right?
So high IVs — read: higher option prices — are great for premium sellers like me, and bad for option buyers on the other side of the trade.
See, in Weekly Windfalls, I use what’s known as “the casino strategy,” due to its high win rate.
I sell options to align with stock support or resistance, and then buy a cheaper option to act as an “insurance policy.”
Because the money I receive from the sold option is more than the money I pay for the bought option, the spread is established for a credit right out of the gate, and thus makes me more of a seller than a buyer by nature.
My goal is to capture as much premium as I can when I initiate the spread, and then let time decay erode the value of the options, so I can pocket as much of it as possible.
How Market Panic Made Me Big Bucks
I’ve been stalking retailer Target (TGT) for a minute, especially with strong support emerging around $110.
In fact, as I told my premium Weekly Windfalls clients, I wanted in TGT last week but just couldn’t get the options premium I was looking for.
However, yesterday morning, with the Dow down about 400 points, I figured that the panic in the market would raise premiums and finally give me the entry I was looking for.
Because remember: fear drives option prices higher.
And wouldn’t you know, it sure did.
As such, I initiated a bull put spread on the stock for a net credit of 88 cents per pair of options.
That 88-cent credit was the most I could possibly make on the spread.
And wouldn’t you know, just a few hours later, I closed out my TGT spreads for 48 cents each, capturing nearly 55% of the total premium!
In real dollar terms… Since each option controls 100 shares of a stock, and since I trade 100 options at a time, I made a cool $4,800 ($0.48 x 100 shares per contract x 100 contracts) guys and gals!
Do you know why?
Well, partially because IVs jumped!
Just last Thursday, Jan. 22, IVs on TGT’s weekly 1/31 112-strike put stood at 18.8%, compared to 25.7% at yesterday’s close.
And a lot of that is because the Cboe Volatility Index (VIX) — also called Wall Street’s “fear index” — spiked as stocks sold off.
The VIX essentially measures expected short-term volatility expectations for the S&P 500 Index (SPX), so big surges typically coincide with market sell-offs.
You can see in the chart below that the last time the VIX was this high was during the October 2019 panic.
However, while stock traders were jumping ship, my Weekly Windfalls subscribers stayed calm, cool, and collected.
That’s because our “casino strategy” allows you to profit in ANY market condition — bullish, bearish, sideways.
And as I told last night’s MasterClass attendees, sellers can collect some very JUICY RETURNS during periods of fear in the stock market.
In other words, this environment is our hunting ground.
So… What are you waiting for? My next big Windfall could come TOMORROW. Join my team!