Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Nvidia Numero Uno in Count Down to President Donald Pump Election Victory - 5th Nov 24
Trump or Harris - Who Wins US Presidential Election 2024 Forecast Prediction - 5th Nov 24
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

When Stock Market Volatility Is Your Best Friend

Stock-Markets / Stock Markets 2015 Sep 08, 2015 - 05:19 PM GMT

By: Investment_U

Stock-Markets

Marc Lichtenfeld writes: Most people who talked to me about the market last week were shaking their heads, trying to make sense of the extreme up-and-down moves. But a few smart investors simply shrugged their shoulders and said, “I don’t care. I’m selling the volatility, so it’s been great for me.”

What they mean is that they are selling options - calls and puts. And they’re not selling them to close positions. They’re starting new ones, but selling first and buying them back when they’re cheaper.


It’s the reverse of buy low, sell high. They’re selling high then buying low.

Volatility is an important part of an option’s price. When volatility increases, so does the price of options.

Be Your Own Insurance Company

Most people don’t care for their insurance companies - who charge a lot for coverage and don’t always deliver what they promise. Wouldn’t it be nice to be an insurer? These companies usually make boatloads of money.

When you sell calls and puts, you are essentially acting like an insurance company. You get to keep the premium and put it in your pocket. And if the event you’re insuring against occurs, you pay the insured.

Here’s how it works. Let’s say an investor wants to buy insurance on his shares of Wells Fargo (NYSE: WFC). He wants to make sure that if the stock goes down, he doesn’t get hurt too badly.

As I write this, Wells Fargo is trading at $53.40. The investor wants to make sure he can sell his stock for at least $50, so he buys a put option with a strike price of $50. If he wants to insure his stock until January, he’d buy the January $50 put. That will cost him $1.80 per share or $180 per 100 shares (option contracts usually consist of 100 share lots).

The seller of the put will collect that $180. And just like an insurance company, if the insured event (the stock falling to $50) never occurs, the seller keeps the money. If the buyer of the put “makes a claim,” the seller must buy the stock from her at $50.

It’s important to note that, similar to buying insurance, the insured event may occur, but the insured doesn’t always incur damage, so she doesn’t collect from the insurance company.

For example, I have insurance for my home against hurricanes. The last time one hit South Florida, the eye passed right over my house. We were fortunate that we lost only a few roof tiles, so I never made a claim with the insurance company.

If Wells Fargo shares fell to $49 next week, the buyer of the put is unlikely to make her claim, as there is plenty of time between next week and January for the stock to rebound.

However, if the stock is at $49 when the option expires in January, the buyer will make a claim and the seller will have to buy the stock at $50.

And just as an insurance company can suffer significant losses when there is a natural disaster, so can a seller of puts.

If Wells Fargo is at $30 in January, the seller is obligated to buy the stock at $50.

However, there are steps the seller can take in advance so that they are not buying the stock at a much higher price than it’s worth. They can buy the put back (most likely at a loss), which would mean they no longer have an open position and are now free of that obligation.

This is a good time to remind you that you should only sell puts if you’re willing to own the stock that you’re selling insurance against at the strike price. So if you hated Wells Fargo, it would not be a good candidate for you to sell puts on. But, if you like the idea of owning Wells Fargo at $50, you’re getting paid $180 to wait and see if the stock comes down to your price. If not, you just keep the insurance premium and write another policy if you choose.

Exploring the Other Side

Selling calls is similar. A short seller might buy a call to protect themselves from the stock going higher. Or an investor might buy a call as insurance against the stock going up without them being able to participate.

Pfizer (NYSE: PFE) is trading at $32.37. If an investor were interested in owning Pfizer at $34 or below, but didn’t want to put up the full $3,400 per 100 shares to participate in the upside - or she wants to risk just a little bit of money that the stock is going up - she can buy the January $34 call for $1 per share or $100 per 100 shares.

The seller of the call collects the $100. If in January, the stock is above $34, the seller of the call must sell shares of Pfizer to the buyer for $34. If the stock is at $50, the call seller must still sell the stock at $34. However, if the stock is below $34, the seller simply keeps the $100.

“Using storms in the market to sell put and call options is a great way to earn extra income.”Finally, a covered call is when you already own the stock and sell a call against it. It’s a great income strategy because you often collect the option premium and don’t have to sell your stock. But you must be ready, willing and able to sell the stock at any time when you’re in a covered call position.

Using storms in the market to sell put and call options is a great way to earn extra income. For more information on how puts and calls work, you can check out The Oxford Club’s Essential Options Manual.

If you have some experience with options and want help selling puts and calls, you can get more information on my option selling trading service Dividend Multiplier here.

The next time markets get volatile, don’t just stand there taking a licking. Use the volatility to your advantage to put money in your pocket.

Good investing,

Marc

Source: http://www.investmentu.com/article/detail/47448/invest-options-market-volatility-best-friend#.Ve8zs03bK0k

http://www.investmentu.com

Copyright © 1999 - 2015 by The Oxford Club, L.L.C All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Investment U, Attn: Member Services , 105 West Monument Street, Baltimore, MD 21201 Email: CustomerService@InvestmentU.com

Disclaimer: Investment U Disclaimer: Nothing published by Investment U should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Investment U Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in