2 Options Trading Strategies to Capture Big Rebounds in the Stock Market
Future of Wealth Head Trader Lance Ippalito joins Midas Letter to discuss opportunities for options traders in today’s economic climate. With news such as the CoronaVirus outbreak and other international economic uncertainty highlighted by the decline in the S&P500 index, Lance shows how to play the market cheaply with out-the-money call options with favourable risk vs. rewards. Lance also discusses how options trading limits the risk as an investor and maximizes the potential reward when stocks do trade higher. Watch the full interview to listen to the Head Trader at Future of Wealth outlining 2 specific options trading strategies with high probability to double your invested money.
James West: I’m joined now by Lance Ippalito, CEO of The Future of Trading. Lance, welcome.
Lance Ippalito: Hey, Jim, how are you?
James West: We’re doing all right over here. Lance, we’re looking at the FAANG stocks here, the S&P is taking it on the chin a bit this week as the influence of the corona virus continues to spread around the planet undermines confidence in market. What’s the opportunity for options traders in this type of environment?
Lance Ippalito: So you hear everyone talk about, if I could only buy Facebook, Microsoft, Google, Amazon, Netflix, at a discount…well, here’s your discount actually today, right now. You have the big FAANG stocks, they’re set to report earnings this week and next week. If you’re wanting a dip to buy them, if you’re wanting to play cheap, out the money call options for a favourable risk vs. reward, you know, try to hit that 300, 400, 500 percent gain, you’re getting this Monday dip, with the virus spooking the markets right now, to play it.
So most traders, they don’t want to buy the dip, they don’t want to buy when there’s fear in the markets. You have to look at the big picture. You have big FAANG; they’re reporting earnings this week. If they beat, you’re going to have a massive move higher in those FAANG stocks, and really, right now is the opportunity.
James West: Right. Okay, so then, what’s the risk that the dip becomes a downturn that persists, and how do you protect yourself against that in the options universe?
Lance Ippalito: Well, the beauty with options is, you can only lose what your initial premium you pay for. So when you buy a call option, for example, let’s say you buy a $1 call option. So that’s representing $100 per one contract. That’s the most money you can pay. Unlike if you were to buy, let’s say, Facebook stock, and after earnings it went down $20, then you’re on the hook for that $20 move in each share of stock that you own.
So you’re getting a limited risk with the option strategy. If, let’s say, Facebook and these FAANG stocks, they continue to dip even post-earnings, unlike the stock, you’re left, you know, hoping and wishing that the stock eventually trades back higher. And listen, I don’t have a crystal ball; I’m not a doctor, I’m not a scientist who’s going to cure the virus spreading over in China. So we could see more downside action.
Again, the beauty of options, you’re limiting your risk and you’re actually maximizing your reward if they do trade higher.
James West: Sure. How important is liquidity to the whole options equation?
Lance Ippalito: The beauty with these FAANG stocks is, they trade mostly hundreds plus thousands of contracts a day, and a name like Facebook and Microsoft, they have penny wide options. The liquidity, you’re pretty much taken care of. You don’t have to worry too much about liquidity. Unlike, let’s say, Google and Amazon; their spreads are a little bit wider, but again, they’re going to trade so many options during earnings that you really don’t have to worry about liquidity issues.
James West: Sure. Okay, and so, why are the FAANG stocks so on fire? What’s driving – they just seem relentless in their march higher.
Lance Ippalito: You look at – let’s say you’re a hedge fund manager, right? And the S&P is returning 30 percent a year or so. These hedge fund managers, they have to outperform the S&P, and the only way they’re really going to outperform is a) where there’s growth and where there’s money flowing into. And really, for the past eight years, and I think, as long as interest rates stay where they are and the Fed, you know, stays okay, we’ll put it there, you’re going to continue to see fund managers continue to buy FAANG stocks. And unless something drastic happens, or unless you think Google or Amazon somehow is going to slow down, you’re going to continue, probably, to see every dip be bought like we have for the past eight years.
James West: Sure. The FAANG stocks seem to be also responding a bit negatively to the coronavirus threat and scare, so is that something that just really prevents an opportunity for somebody who wants to buy the dip? Or, is it potentially a longer-term threat? I mean, if you’re only on the hook for the cost of your option itself and not for the downside, I guess at some point you either reverse your theory and play the short side, or do you just stay out of the market altogether and wait for a more discernible pattern?
Lance Ippalito: That’s a good question. It kind of reminds me of, remember the whole Ebola scare? I think that was, what, a number of years ago? It was really short term. The S&P actually went 15 percent lower, and then three months after, it had a V-shaped bounce; it was actually trading 25 percent higher.
In my opinion – again, I’m not a medical doctor or scientist – but usually when we have negative news, money will come out of FAANG stocks because, you know, they’ve ran up so far, really so quickly, that you’ll have profit-taking in those high beta names. And then as soon as you have, let’s say for this virus, the worries and the cure is solved and just we bypass it, you have money go right into those FAANG stocks all over again, and that’s what causes that bounce.
Listen, if you’re worried, if you’re scared, you don’t have to play; you don’t have to be in the market. That’s the beauty of trading. It’s your money. You do what you want. But if you do think there’s an opportunity, and historically, these short-term dips on, whether it be illnesses or diseases or fears in the market, they’ve, you know, they’ve seen higher prices shortly after.
James West: Right. Okay. So then, what are some of the strategies that you can use to really capture a rebound in the stocks through an options strategy?
Lance Ippalito: I want to go over two strategies, and they’re both very simple to do, and as a trader or as an investor, anyone can do them. Number one is a premium selling strategy. So you’re basically putting a 50/50 bet. It’s called a bull put credit thread. So unlike selling a naked put, where you can get assigned stock and that you do have a limited risk to the downside, you’re actually buying it out the money put, selling in the money put. So, a neutral strategy on this (unintelligible) price level by expiration, you’re good. So basically you’re risking $50 to make $50, and the stock doesn’t even have to move higher.
So it’s a very conservative, neutral strategy that traders can do for a high probability percentage to really double their money.
Another strategy, and this is more aggressive, is buying calls. The negative with buying calls is around an earnings event, or when there’s fear in the market or uncertainty, option prices increase. So those call options are going to increase. But, if you do have a V-shaped bounce or a sudden, aggressive move higher in a stock, the call options are your best bet for the greatest return possible on a trade.
So I’ll go over a hypothetical situation. Facebook has earnings. Facebook stock right now is trading right around $215. The market-makers are implying a $15 move higher or lower on earnings. So that’s $200 to the downside, $230 to the upside.
Let’s say Facebook trades $250. They have a fantastic quarter, they beat analysts’ expectations. You can buy those $230 calls for about $1, and if that stock goes to 250 – pardon me, they’re about $2. Two dollars. If Facebook trades at 250, those calls are going to be worth $20. So that’s 10X your money in a matter of weeks, if Facebook has a positive earnings result.
James West: Right. Okay. So then, now, if I’m an individual investor, what is the best platform for a small trader in the options space to get their feet wet, so to speak?
Lance Ippalito: There’s so many options now, it’s really a fantastic time to be a trader. I use TD Ameritrade Think or Swim; it’s very advanced. You can get every feature you ever asked for, especially if you’re a big math fan, via options stats, probability analysis, it goes into all the Greeks and detail. It even has education, fantastic charts and scan features. It’s a little more pricey; they just merged with Schwabb, so they cut, for stocks it’s free, but for options it’s still $0.65.
If you’re more into swing trading and more conservative, not so aggressive, you know, you’re not trading hundreds of orders a day, I use Robin Hood. They have a web-based platform or mobile on your phone. It’s completely free for trading options, and in my opinion, it’s really not that bad. I’ve used pretty much every platform out there. You know, I spend tens of thousands of dollars a year on commissions, and it’s free! You know, I’m saving a ton of money using Robin Hood on one of my accounts, and I like it.
You really can’t go wrong, now. You have options, and that’s always beautiful.
James West: Right. Okay. In what general market conditions is trading options better than trying to catch a run to the upside or the downside in stocks?
Lance Ippalito: So when you trade options, especially when you buy call options betting a stock goes higher when you buy put options thinking a stock moves lower, you really only need some kind of volatility in the market, because volatility creates opportunity. And when you’re trading directional, whether it be up or down, that’s what you really want as an options trader.
When the market is flat and not doing anything, it can be really boring, because you don’t have as many opportunities to move higher in a stock. So, like, right now, with the virus scare, and you do have the market moving, you know, we gap lower today, we might gap higher 50 handles in the S&P tomorrow. If you’re trading options, that’s what you want, because it presents opportunity to trade.
James West: Right. All right, that’s a great introduction, there, Lance. We’re going to leave it there for now. We’ll come back to you next week. Thanks very much for joining us today.