This is the last weekend before the beginning of school for the kids in my suburb outside of Chicago. Oh for the days when we just worried if mean Mrs. Hall was going to be our first grade teacher or the little red head girl we were afraid to speak to was going to be in our class….
Options Action –
The show began with an overview of the markets. A couple of interesting thoughts came out of the banter. First, it was noted that many option trades appear to be coming in with the thought that another shoe is going to drop and the result will be a drop in the markets. Bearish positions going out to October expiration seem to be a common theme. Also, it was pointed out when analyzing the option activity in the industry related exchange traded funds that the highest volatility is showing up in funds focusing on financial stocks. The feeling here is the perceived risk is in this sector and this is the sector that will lead the markets over the near term.
The first recommendation was a bearish call on the overall market using SPY option contracts. A put spread buying the higher strike put and selling a lower strike put is recommended. With the SPY closing at 112.61 on Friday, the recommendation was to use the Weeklys that expire on August 26th. Using Friday’s closing prices, buying the 110 Put would cost 1.65 and selling the 105 Put would bring in 0.80 for a net cost of 0.85. The S&P 500 (and SPY) would need to drop a little over 2% this coming week for the trade to break even. A drop of around 7% would result in a profit of 4.15. Any outcome will be known by this time next week as these contract expire this coming Friday. As a final note, the panelists did recommend taking this trade off if a quick move down comes before Friday. If you have a good piece of that 4.15 showing up as an unrealized profit, you may want to book it and close out the trade.
The next recommendation was also of a macro nature. Using technical analysis, the feeling is Gold may be prepared for a pullback after the most recent price spike. Using GLD options, if you have a long position in gold using the GLD exchange traded fund which closed just under 180 on Friday, you may want to consider a cashless collar. The suggested collar offers protection to the downside and some price sacrifice to the upside by purchasing an October 170 Put for 3.60 and selling the October 190 Call at 4.60. The net result is a credit of 1.00 for initiating the collar. Also, profits for the long GLD position are capped above 190 and losses are limited below 170. It was acknowledged that the bulls dominate the gold trade these days, but the quote that followed this acknowledgement was a classic, “When everyone is looking up, look down.”
In the Striking Price column Steven Sears discusses how Warren Buffet makes money. In a nutshell, Buffet makes money through buying quality stocks and often buying stocks when the majority of investors seem to be going in the other direction and exiting the markets. Now is one of those times as the stock market continues to trade lower from week to week.
What also occurs in these more volatile times is an increase in the implied volatility for both call and put options. Sears runs through a couple of option strategies that are attractive in times of higher volatility. Taking things down to a basic level, in times of high volatility, the implied volatility for both put and call options is usually high relative to historical implied volatility. At these times, selling options opportunistically may be an attractive strategy. A call seller takes on an obligation to sell stock and a put seller takes on an obligation to buy stock. Again, in times of higher volatility, the premiums received for these obligations are higher than in times of low market volatility.
As for the Rhoads household, Saturday afternoon the postman brought a letter from school telling us that Mrs. White is going to be our first grade teacher! We had hoped for this all summer as she helped once with a snow boot debacle last year. However, we are not sure if Tyler from down the street is going to be in our class. It’ll be a double win if he shows up in Mrs. White’s class next week. Would it be nice if that’s all we had to worry about?