Stock markets have turned volatile recently, as we’ve discussed previously, but I expect more to come so keep your seatbelts securely fastened!
Amid turbulent and uncertain markets, one way to take easy advantage – with limited risk and large upside profit potential – is with options. And in this column, I’ll brief you on our exclusive TradeSmith tools that can stack the odds of success in your favor.
Also, I’ll introduce you to an options trading expert from our corporate partner Masters in Trading: Jonathan Rose, who spent over 15 years as a professional floor trader, then went on to become an options market maker as well as educator. Jonathan developed his own system for stacking the odds of success in his favor. And he has the track record to prove it.
So, let’s dive right in.
It’s an election year. In addition to the usual volatility triggered by earnings, the Federal Reserve, and economic data, the election is another reason to prepare for market turbulence to increase from here.
While candidate polls fluctuate as Election Day draws closer, so too does stock market uncertainty increase as measured by the CBOE Market Volatility Index (VIX). As you can see below, the VIX has a definite historical pattern of increasing by 25%, on average, in the months ahead:
To take advantage of rising volatility, Inside TradeSmith readers are familiar with our exclusive, AI-driven option trading tools, specifically our Probability of Profit (POP) indicator: the heart of our Options360 software.
TradeSmith has a few timing indicators, and out of all of them, this Probability of Profit is my favorite way to time options trades. And it’s had a 95% (or higher) success rate ever since we released it.
With POP, you can see the statistical likelihood of a stock hitting a certain target price by a specific date. That means you can significantly stack the odds of success in your favor with disciplined, income-producing options trades… raising your chances of making money on each trade.
I’ve found POP to be very effective when it comes to selling put options on stocks I want to buy at a discount, or selling covered call options on stocks I already own. And right now is a great opportunity to take full advantage.
The S&P 500 pulled back a bit more than 5% before bouncing back over recent weeks. Still, there’s bound to be plenty of both up and down volatility in store for investors as this year unfolds. Especially in an election year!
When it comes to selling options (both puts and calls), higher volatility can be your best friend. That’s because higher volatility increases the premium income you can earn for selling options. I’ll show you how.
How I Used My Favorite Indicator to Find a High-Probability Tech Trade
I’m always working on my shopping list of high-quality, dividend-paying stocks I would love to own at a discount. Not long ago I placed a personal trade on one of the best-positioned mega-cap tech stocks in the market: Alphabet (GOOGL).
GOOGL just reported stellar earnings last week and, with that possible landmine out of the way, it’s a good opportunity to buy this tech blue chip on the cheap.
But instead of simply buying shares of GOOGL at its current price near $169, I could first sell a put option on the stock to try and buy the shares even cheaper – and get paid cash money to do it.
When you do this, it’s like putting in a low-ball offer on the stock at a price you decide. For each put option you sell, the investor on the other side of this trade has the right to put (or sell) you 100 shares of GOOGL at the option strike price until expiration date.
All the details for this option can be found in TradeSmith Finance. Just enter the ticker symbol, GOOGL, in the Search for Ticker box at the top right. Then click on Options in the menu tabs and select Sell Put.
That will bring you to the page shown above in Calendar view, where you’ll see details including the POP and ROI (Return on Investment) for available options at different strike prices and expiration dates.
By using the arrow pointers next to Expiration Date and Strike Price, you can scroll through dozens of options to find the right one for your objective.
I scrolled down in strike price, to the GOOGL $150 put option that expires May 31. And by clicking on that option’s tile, you’ll get all the important details for this trade.
I’ve numbered these details from top to bottom.
1. This option has a strike price of $150 and expires May 31. Bear in mind, that strike price is 11% below the current GOOGL stock price (near $169). That would be a bargain buy price in my book.
2. The Max Profit is the option premium income you earn up front; in this case $48. And the POP is 74%. This means that the odds of the option being in the money by expiration are roughly 1 in 4, or a 26% chance. For every option contract you sell, you earn $48 in income. And in exchange, you could have shares put to you at $150, about 11% lower, if GOOGL drops through that level.
3. For a standard margin account, your broker will require $1,666.11 of free Buying power to place the trade. And the ROI is 2.88%. That’s 2.88% return for about a one-month trade, or roughly 34% annualized!
4. If you don’t use margin trading, then the cash you’ll need available to place this trade is higher, at $14,952. Naturally, that lowers the ROI on this trade.
Finally, the Underlying Asset Price Forecast graph at right visually demonstrates the probability of success. You can see that your breakeven on the trade is all the way down at $149.54. And based on the trading history of GOOGL, there is a 74% probability of the stock staying above that level.
If so, you’ll keep your $48 profit and perhaps consider placing a similar trade all over again next month. Rinse, lather, repeat – all the while getting paid cash income for the privilege of buying this blue chip at a substantial discount.
There’s a tradeoff here between POP and ROI. Selecting a higher strike price, you’ll have a lower probability of the option expiring out of the money. But you’ll earn a higher ROI on the trade.
And if you go with a higher probability (that is, lower odds of the stock being put to you) then you’ll have to accept a lower ROI. But the beauty of Options360 is that you can dial up the trade with the right probability and income return for your objective.
Of course, there is more than one way to skin a cat, or to become a successful trader.
How Masters in Trading Spot Potential Pivot Points in Their Stocks
Based on his time as a floor trader at the Chicago Mercantile Exchange and making as much as $1.1 million a year trading Nasdaq futures, Jonathan Rose developed unique indicators to pick up on unusual trading activity that led to trades with a 90% win rate.
Jonathan is an expert at identifying key support and resistance levels for stocks and ETFs with his own technical indicators.
Lately, he’s been closely watching the Invesco QQQ Trust (QQQ), an ETF tracking the Nasdaq 100 Index. And in one of his Masters in Trading videos recently, he pointed out a key pivot point in QQQ at $433. That’s a key inflection point between support and resistance for the Nasdaq.
With volatility on the rise last month, Jonathan suggested short-dated put options on QQQ to hedge the growing downside risk. And sure enough, as you can see above, QQQ broke below this key “line in the sand,” as Jonathan calls it, early last month. This triggered a sharp sell-off in QQQ that allowed the put options he suggested to jump 179.9% literally overnight!
That shows you just how powerful a smart, data-based trading strategy can be to help you make money even in volatile markets.
Mike Burnick’s Bottom Line: Options can be a powerful tool in your trading kit, but plenty of folks get intimidated. That’s why Jonathan Rose has spent the last nine years showing everyday folks how to become more profitable in their trading. He also produced three full-length videos that detail almost every step of his winning process, and you can get full access to them here.
Good investing,
Mike Burnick
Senior Analyst, TradeSmith