I think I have found the perfect options trade . . . at least that’s what a few subscribers told me last week. You decide. I’ll be going into more detail about this type of “perfect options trade” in a free income event I’m hosting. You can click here to attend.
As you can see in the Powershares Nasdaq 100 (NASDAQ: QQQ) chart below, the QQQ fund has pushed significantly higher over the past few weeks. As a result, the RSI (2) and RSI (5) are in an “overbought” state.
When this type of short-term move occurs, mean reversion – the tendency for a stock to return to its average price – usually kicks in. In this case, QQQ has moved several standard deviations away from the mean. ONE
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.
If this topic seems a little bit difficult or confusing, consider attending my free live event. This event is a better medium to explain how this trade works, especially since I can answer your questions live. Click here to see the details.
So, when we know the move is somewhat of an anomaly as seen through the RSI pushing to “overbought” levels, I immediately want to fade the directional move. When I fade a move – in this case a bullish move – I am hoping for a short-term reprieve in the underlying price. The price could move lower, trade sideways or simply plod slowly higher. I’m just hoping for the laws of mean reversion to kick in.
But I increase my pot odds by wrapping a high-probability strategy around the trade. Rather than take a directional bias and simply buy puts, I want to sell calls, more specifically bear call spreads.
In this case, since QQQ is currently trading for $126.96, I want to sell a call at a higher strike. But which strike? I always start my search with the strike that has an 75% probability of success, preferably over 80%. What that means is that at expiration in 36 days, there will be at least a 75% chance that QQQ will close below that strike.
As you can see from the option chains above, the 130 strike meets my requirements.
We can sell the 130 call strike and buy the 132 strike for a net credit of $0.33.
Our return on the trade: 19.8%.
Basically, as long as QQQ stays below our short strike at expiration we will reap the entire premium of 19.8%. There is a 77.92% probability of success that the price of QQQ will stay below our short call strike of $130 at expiration in 30 days.
More on the Perfect Options Trade
But I’m fine taking 10% . . . just shy of half the original premium of $0.33. So, when the spread is worth $0.18, I typically begin to take the trade off. I do so because research shows that taking the trade off at roughly 50% of the original premium is a far superior approach than waiting until expiration. If you would like to know more about this type of “perfect options trade,” check out my upcoming free event on this topic.
I’ll be revealing three live trades that are similar to this QQQ trade, and they could add instant income to your brokerage account.
Remember, we are wrapping a high-probability short-term trade on an ETF that has already pushed into a “very overbought” reading. This increases our pot odds on the trade that much further and it’s why I’m not placing trades every other day. It’s a methodical, patient approach.