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A MOST AGGRESSIVE RETURN ON A MOST CONSERVATIVE TRADE IDEA
If you actively trade stocks, volatility is your friend – it’s where the action is. Big price swings. Massive breakouts. Stocks crashing to new lows. Tradable support and resistance.
But options traders? They usually get it wrong—because they usually BUY expensive options amidst high volatility. If you are buying options, volatility can be your enemy. Smart money is SELLING expensive options—and premiums for options continue to go up and up.
Selling covered options can be a very high reward, low risk strategy with a very small bit of learning. Sure, It’s not as cheap as selling naked (!!) puts and calls, but long-term returns are usually better as you rarely take a big loss.
Here’s a very recent—and very real—example of how most investors trade options.
Unless you were in a coma, you know there was a banking crisis these last couple weeks in the USA.
One of the most affected banks was First Republic (FRC-NYSE):
Before the shares collapsed, at-the-money one month put contracts on First Republic Bank (FRC-NYSE) cost $4.50 – or roughly 3.2% of the share price. Post-collapse? One month at-the-money contracts cost $4.80 – a whopping 39% of the current share price.
Put differently, If you buy at-the-money FRC puts today, the shares have to plunge 39% over the next month… Just to break even! Prior to the collapse? A mere 3.2% decline was needed to break even.
Why?
In the options market, you pay for volatility up front and higher volatility = more expensive options. If you’re BUYING options, that’s not so good. But if you’re SELLING them…CHA CHA CHA!!
A savvy options trader might short FRC shares and WRITE (which means SELL) the $12.00 April 21st puts, taking in the massive $4.80 premium.
Chances are if subscribe to an options newsletter or screening service, at this very moment you are being pitched options trades on FRC and bank ETFs like the BKX.
If high volatility trades like these are consistently working for you, stop here. Don’t read another word. We’ve taken enough of your time.
GENERATING HIGH ALPHA IS A LOT EASIER WITH OPTIONS…
AND HERE’S A GREAT TRADE TO PROVE IT
If high-vol trades aren’t for you…our soon-to-be-launched newsletter – called In The Money – will not recommend high risk, high volatility trades like pretty much everyone else. In fact, we will avoid them!
Instead, we look for moderately elevated volatility on companies (and ETFs) we follow and have strong views on. An example right now is the iShares 20+ Year Treasury Bond ETF (TLT-NYSE).
TLT Weekly Covered Calls
We like owning treasuries here – inflation is falling (you can argue how much), economic risks are increasing, and the Fed will likely reduce the rate they are selling Treasuries in coming months.
Based on these factors – and where we are in the investment cycle – we strongly believe Treasury yields will fall from the current 3.64% to somewhere between 2.50% to 3.00% in 2024. Because bond prices rise as yields fall, this should send TLT shares somewhere between $122 and $132 per share. And that’s before the modest 2.6% yield.
It gets better.
Besides being stock analysts… And economists… We also watch charts. And the TLT chart is getting interesting:
A chance to make a roughly 20% to 35% total return over the next year or so is pretty compelling. But like you, we like options.
As luck would have it, the recently volatile jobs and inflation data – not to mention bank failures (doh!) – has led to a jump in implied volatility on TLT options:
https://www.alphaquery.com/stock/TLT/volatility-option-statistics/30-day/iv-mean
Astute options traders will notice the average volatility is still just .21 – which few options traders would call ‘high.’ But the bank crisis has treasury volatility at the highest level since the start of the pandemic in 2020
As an example, volatility on QQQ options has ranged between .21 and .36 over the past year. META? Currently .42 down from .65 in January.
But FRC was an off-the-charts 3.8!!!! In the history of all options trading, that’s likely a 99.9th percentile number.
Back to TLT–the OPPORTUNITY being presented by modest volatility in TLT options is anything but boring. At Friday’s close, we could buy TLT shares at $106.85 and write (SELL!!) $107 calls expiring this coming Friday (March 31st) for $1.25 (midpoint).
Sure, the shares will likely be called away – meaning the stock will likely go higher than $107 and they buyer of the calls will take away out shares—but we would make $.15 on the shares (selling them at $107) and keep the $1.25 call option premium.
Our return on the position could be 1.31% for the WEEK. That equals a 68% annual return using no margin and no compounding.
The next week we would repeat the trade, buying TLT share (albeit at slightly different share prices) and writing at-the-money calls for the following Friday.
If TLT shares close below $107.00 on Friday, we keep the weekly call options premium and are left the shares, only to write ‘at-the-money’ calls again on Monday morning. (Don’t worry, once In The Money goes live, we will do all the thinking for you…)
Now look, with a trade currently offers a 68.1% annual return without using margin and without compounding–we only expect this opportunity to last a few months,
Why are we giving you one of our favorite trade ideas for free? It’s great example of the difference between our upcoming IN THE MONEY service and most other options services: While other services offer the hope of double-digit returns making risky trades on uber-volatile stocks – often found via volatility screening with no regard for the fundamentals.
We only recommend call options trades on large cap, highly liquid shares that we want to own for fundamental reasons*. We’ve done the work. We know the name. We have a view.
And we like owning Treasuries here.
Happy trading!
– IN THE MONEY
* We will recommend covered puts as well, but on shares which are high-conviction shorts
IF YOU WANT TO BE ON THE LIST FOR OUR NEXT OPTIONS TRADE IDEA–WHICH WILL BE FREE–CLICK HERE!!
