FAANG stocks: That’s what I’d like to discuss with you today. Those are Facebook, Amazon, Apple, Netflix and Google.
But before I go into more detail about how to trade options on FAANG stocks, I want you to think about the last stock you purchased.
Now think about why you chose to buy stock in that company.
Certainly, you did your due diligence. You know the revenues, profits and expenses, and of course the company’s five major competitors and main suppliers. You wouldn’t dare buy a stock just by looking at the chart . . . or would you?
Unfortunately, most individual investors can’t answer any of those questions. Yet, investors will invest their life savings in a company they know very little about. But who really knows the answers to those questions? Experts, of course. There are facets of a company that analysts will spew out that you never knew existed.
But frankly, who cares?
Knowing everything you can about a company and making money are two different things. And confusing the two is where most investors, individual and professional alike, are led astray.
It’s all “fugazi.” Those of you who have seen “The Wolf of Wall Street” know what I’m talking about. Sadly enough, most investors are sold a story and nothing more. In many ways, it’s what Wall Street was built on.
And that is exactly why I use options.
I’m not going to allow a story to define how I invest my hard-earned money. I make investment choices based on a “rational” approach of evaluating hard statistics: maximum risk and reward, probability of profit, and expected return. Before I make any investment decision I know the exact percentage of each statistic mentioned above. Again, no stories or the soft data we are accustomed to seeing from the financial community . . . just hard statistics.
Let me take you through an example of how I evaluate each and every investment I make using one of the FAANG stocks. FAANG stocks consist of Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Google (GOOG). I’ve recently started a FAANG-based portfolio for my Options Advantage service and will be discussing the details of the portfolio strategy using several trade examples in my upcoming webinar.
The first question I always ask myself when looking at a potential option trade is, “What is the most I can make or lose on this trade?” Fortunately, in the world of options the numbers can easily be calculated so that you can make a logical decision based on your risk/reward tolerance.
On June 22, with Facebook trading for $154.01 and in a very overbought state, I want to sell a few vertical call spreads.
Think about a “very overbought” move in terms of the standard bell curve. When something is “very overbought,” it has moved to the outer fringes of the curve.
A vertical call spread is an options strategy for those who are bearish or neutral on a stock. The stock can actually move slightly higher as well and you will still make a max profit. When a stock or ETF for that matter is in an overbought state, I want to sell vertical call or bear call spreads.
I want to sell the 157.5/160 vertical call spread for $0.66, or $66 per spread. The max risk on the trade was $184 . . . and if FB stays below our short call strike of $157.5 the potential return is 35.9%. However, in most cases, I prefer to lock in 50% of the original premium by buying back the spread early.
At first glance the risk/reward seems off to those new to options. I always get the same question: “Why would you risk $184 to make $66?” . . . followed by the second question, “What are the chances that this will be a profitable trade?”
The answer is simple: the trade has a high probability of profit: 67.6%. In fact, I can cater each of my trades to fit a certain probability of profit so I always have an edge.
In this case, if Facebook doesn’t push past the short strike of my spread or $157.5 I will make a max profit on the trade. That’s a margin of error of 2.3% (the difference between the current price or $154.01 and the short call strike of $157.50). I challenge investors to find a stock trade that allows you to be directionally wrong 2.3% and still make a profit.
Again, this is why I use options.
In summary, as long as FB stays below our short call strike ($157.5) at expiration we will reap the entire premium of 35.9%. There is a 67.6% probability of success that the price of FB will stay below our short call strike of $157.5 at expiration in 29 days.
Remember, we are wrapping a high-probability strategy on a stock that has already pushed into a “very overbought” reading. This increases our pot odds on the trade that much further due to the laws of mean-reversion and it’s why I’m not placing trades every other day. It’s a methodical, patient approach and one that I am willing to wait to present itself.
With the recent decline in FB we can now take the trade of for roughly $0.40. This would equate to an 11.6% in just 8 trading days. As I said before, I prefer to hold on to the trade until at least 50% of the original premium ($0.66). That being said, I plan on holding on to the trade a bit longer until my premium goals are met.
If you like this kind of idea, I offer a FAANG Portfolio and four other options-selling strategies in my Options Advantage service. Check it out. Join. Or simply email me with any options-related questions regarding all things options.
For those of you who reside in the United States, have a wonderful holiday weekend. And for the rest of you, well, much of the same. Thanks again for all of the support and kind words.
Until next week . . .