As options traders, we welcome fear in the market.
In fact, more specifically, as options sellers we thrive on fear.
We stay clear of market prognostications and focus on what’s truly important: making money. Don’t get me wrong, I enjoy being entertained, but I save that for truly creative forms of entertainment, not a market pundit guessing which way the market is headed.
Remember, the stock market is 98% marketing. Why do you think we have endless opportunities to listen, watch or read anything we want about the stock market? Because the latest and greatest is what sells.
As someone who believes in the efficient market theory, I couldn’t care less about what other people have to say about the market. As Eugene Fama – American economist, Nobel laureate in economics and widely considered the father of modern finance – states, “I’d compare stock pickers to astrologers, but I don’t want to bad mouth astrologers.”
But I digress … back to why we, as options traders, should embrace fear in the market.
It’s called volatility, and it’s one of the key factors when trading options. Volatility – more specifically implied volatility – is a crucial element both in options pricing and in the profitability of any options trade.
Fear and volatility go hand in hand.
Simply stated, as fear in the market increases, options prices increase.
For example, look at the recent drubbing in United States Oil ETF (USO).
The ETF has experienced a sharp decline due to the fall-off in oil prices. As a result, implied volatility has pushed from 34% back in October to where it stands now at over 50%.
The 16% increase in implied volatility means we can sell options in USO for significantly higher prices. As options sellers we love selling options for higher than normal prices.
So naturally, as a contrarian, I absolutely love when highly liquid, low beta stocks or ETFs take a hit.
USO is not the only ETF that has caught my eye over the past few weeks. I also like the Market Vectors Russia ETF (RSX) and the Market Vectors Gold Miners ETF (GDX).
Let’s take a quick look at a potential trade I might make in, say, GDX.
As most of us already know, gold has taken a beating over the past few years. During that time I have consistently been selling puts. In fact, for my High Yield Trader service I have made 74.2% selling puts while the ETF has lost 30.2%.
With GDX currently trading for $19.04, I can sell the May 17.5 puts – with a probability of success of 72.83% – for $0.33, or a 9.4% return. If I wanted more premium I could look toward selling the May 18 puts – with a probability of success of 65.55% – for $0.47, or a 13.1% return. It truly depends on your investment goals.
The one important aspect that you need to remember when selling puts is that it needs to be on a stock that you don’t mind owning, because you will eventually be issued stock. It’s only a matter of time. And when you are issued stock, you will most likely want to start selling calls until the stock is eventually called away. And that is where you start the whole process over again. I call it the income cycle, and I have been using it successfully in one of the portfolios, appropriately named The Income Cycle Portfolio, for my High Yield Trader service.
So stop listening to other so-called professionals’ guesses as to where a stock is headed. Pick a stock you want to own for the long haul and try to lower the cost basis by selling puts. More importantly, do so with a real probability attached to your trade. Not the marketing-driven, arbitrary guesses made daily by the financial media outlets.
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