So it should come as no surprise that they each have different ways to approach market volatility.
Buy-and-hold investors fear that volatile markets will slash the value of their stocks.
While traders ride gyrating stock prices to quick gains — often playing moves to the upside and the downside.
On the other hand, investors love periods of low volatility in stocks… While traders cringe at stagnant share prices.
Free Reports:
Now, the current market situation might have some investors out of the game. But a simple adjustment to your strategy could change everything.
As senior analyst Jonathan Rodriguez details below, there’s a low-risk way for investors to play the current market like a short-term trader…
Ahead of the tape,
Louis Basenese
Chief Investment Strategist, Wall Street Daily
To be sure, the market has cooled off considerably since Donald Trump’s presidential election win. And investors are playing a mellow game of wait-and-see as the president’s legislative agenda unfolds.
Don’t follow their lead!
Now is not the time to sit on the sidelines. But it’s also not time to load up on pricey shares of your favorite companies.
Instead, now’s the time to “replace” these expensive stocks using options.
As you may know, options derive much of their value from the price of their underlying stock.
But another major component in their pricing is volatility.
When volatility is high, option prices become more expensive as traders buy them up — hoping to make quick profits. Conversely, when the market is calm, options become cheap.
So in other words, when the market becomes complacent, a savvy trader can substitute their stock for cheap options.
Stock replacement is particularly useful during times of market uncertainty, coupled with high valuations. And the future profits can be several times greater than the stock gains, with even less risk.
There are two main ways to implement a stock replacement strategy: using an out-of-the-money (OTM) call option or an in-the-money (ITM) call.
Here’s a quick rundown on the difference between the two…
An OTM call is an option with a strike price that’s higher than the current price of the underlying shares.
This type of call is cheaper than an in-the-money call because it doesn’t actually hold any “intrinsic” value.
For instance, say XYZ Co. is trading for $10 a share. An OTM option with a $15 strike price is less valuable than an ITM call with a $5 strike.
In this example, the ITM option has $5 of intrinsic value built in. That is because the owner of the option can buy XYZ shares at $5 and sell them at the $10 market price for a profit ($10 share price – $5 strike = $5).
Pretty simple, right?
Now, both types of options come with advantages.
An OTM call option boasts an advantage. Not only is it cheaper to purchase when you enter the trade, but it also allows you greater leverage to increase your profit potential.
The downside is that until the option trades ITM — when the stock price moves higher than the option’s strike price — you’ll capture less of a profit on the underlying stock’s rise.
This correlation between the option’s price and the underlying stock’s price is called “delta.”
So what’s the advantage of an ITM option?
An ITM option is more intrinsically valuable — and as a result, it’s more expensive. However, ITM options have higher deltas — meaning these options follow the underlying stock more closely.
Plus, despite their premium price to OTM calls, they can still reduce an investor’s cost basis to owning shares by at least half.
Want to learn more?
Next week, I’ll dive into examples of both replacement strategies at work.
Stay tuned.
On the hunt,
Jonathan Rodriguez
Senior Analyst, Wall Street Daily
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