I hope this email finds you well and not stir-crazy.
As coronavirus fears came to a boil, it was Wall Street’s worst week since 2008.
And while no one can deny that the market looks bleak, there are some incredible opportunities for option sellers.
Now, if you don’t know what I mean by that, it’s okay.
I’ve put together a mini options course detailing what you need to know to get started with options. And more importantly, why now could be the greatest time to be an option seller.
2 Types of Options
There are two types of options: calls and puts.
In a nutshell, if you buy a call option on a stock, you’re expecting it to go higher.
If you buy a put option on a stock, you’re expecting it to go lower.
Of course, it’s not nearly as simple as that, but that’s the general gist.
To be specific, a call option gives the buyer the right (but not the obligation) to buy 100 shares of a stock at a predetermined price (the strike price) by the option’s expiration date.
A put option gives the buyer the right (but not the obligation) to sell 100 shares of a stock for a predetermined price (the strike) by a predetermined date (expiration).
But Jay, you ask, what does that mean?
Don’t worry, favorite pupil, I’ll break it down.
3 Questions for Option Buyers
When you buy an option, you have to decide three things:
The strike price is the level at which a call buyer expects the underlying stock to conquer, or the level at which the put buyer expects the shares to breach or stay beneath.
The options series determines how long the buyer expects the move to take.
See, there are options expiring every single Friday! While many small-cap stocks don’t have weekly options yet, or even some mid-caps, most all big-cap stocks have weekly options — or options that expire at the close each Friday.
So a call or put buyer usually has a plethora of choices as far as picking an options series to align with their expectation for the shares.
Both the strike price and the option series play big factors in how much each option costs.
If an option is already in the money (ITM) — where the stock is above the call strike or below the put strike — it will be more expensive than one that is out of the money (OTM), which is when the stock is below the call strike or above the put strike.
And the longer an option has until expiration, the more expensive it will be. That’s called time value.
How Fear Affects Option Prices
The other main component of an option’s price is implied volatility (IV).
In the simplest terms, IV reflects the market’s expectations for a stock’s volatility over a certain period of time.
Rising IV = rising option prices.
See, when traders expect a stock to be volatile, they’re willing to pay more to buy those options.
That’s because compared to options on a relatively predictable stock, the options on a volatile stock have a better chance of moving ITM by expiration, because the shares could make a monster move.
That said, let me introduce you to the Cboe Volatility Index (VIX), if you’re not already acquainted.
The VIX is often called the “fear index” of Wall Street.
That’s because it reflects short-term volatility expectations for the S&P 500 Index (SPX), which is the major stock market index in the U.S. (along with the Dow and Nasdaq).
So, a rising VIX means rising volatility expectations for stocks, which you’ll see a lot when traders are nervous (hence the “fear index” nickname)… like right now.
I mean, we haven’t seen a VIX this high since the 2008 financial crisis — which means options in general are expensive.
Why Now’s the Time to Be an Options SELLER
There are two types of options traders: buyers and sellers.
However, unlike most tangible assets, when you’re an option seller — like I am in Weekly Windfalls — you don’t have to buy the option before you sell it.
You can just jump right in and take the sellers’ side.
And as with anything, if you’re a seller, you want to get as much money for your goods as possible — higher prices are a good thing.
I mean, we were already at an advantage over option buyers by default, considering nearly three-quarters of option trades resolve in the sellers’ favor.
They call my credit spread the “casino strategy” because of its high win rate, and that’s because you can make money if the stock:
- Moves in your favor
- Moves slightly against you
- Doesn’t move at all
In other words, while an option buyer has to choose the direction, magnitude, and timing of a stock’s move in order to profit, an option SELLER just has to determine where the stock WON’T go in a period of time.
Check this out.
Here’s an options chain for MSFT, featuring prices for contracts expiring on Friday, April 24.
Typically, options that are BOUGHT trade closer to the ASK price, while options that are SOLD trade closer to the BID price.
If you expect MSFT shares to stay above, say, $136, it would cost you $13.80 to buy the 136-strike call.
That would put your breakeven at $149.80 (strike + premium paid), compared to MSFT’s current price around $137.
However, you could SELL the MSFT 136-strike PUT for $8.50, and you’ll likely get to retain a chunk of that premium as long as the stock doesn’t go below $136 before expiration.
Meanwhile, if you were bearish on a stock, instead of buying a put, you could opt to sell a call option — and you’d stand to make money as long as the shares didn’t go above that strike price within the option’s lifetime.
I hope you enjoyed your crash course in buying and selling options!
However, it’s important to remember that “naked” options selling is dangerous… and one of the big reasons I love my “casino” strategy is that you know your risk upfront, and it’s limited.
That’s because the vertical credit spread is comprised of a sold option, but also a cheaper, bought option to act as an “insurance” policy against a move against you.
Not a bad thing to have in this wild market.
But we’ll get into credit spreads more next time…
Speaking of WILD, guys and gals, make sure you register for my LIVE EVENT at 8 pm ET this Tuesday! I’ll be discussing the state of the markets, and show you how to make money in any environment as a part-time stock trader! See you there.