Thursday, March 12, 2009
Next Friday, March 20, is option-expiration day. All March put and call option contracts expire on that day.
If you believe, as I do, the rally that began on Tuesday will continue for at least a few more days, then there's a ton of money to be made. But you won't make it by betting on the upside. You need to bet against the downside.
Let me explain...
Option premiums are huge right now. Anyone buying calls and betting on the upside needs to see their stocks rally by 5%-10% over the next week in order to profit on their trades. While that's possible, it's a low-odds bet.
Betting against the downside makes more sense. In other words, I'm more inclined to sell put options than to buy call options.
Selling put options obligates you to buy the underlying stock at the agreed-upon price. And it pays you upfront for that obligation. For example, if you want to bet Yahoo (YHOO) will rally with the stock market over the next week, you can sell the YHOO March 13 put options (YHQOM).
These puts are selling for about $0.45. So you'll receive $45 per contract and you'll be obligated to buy 100 shares of YHOO at $13 per share if it closes below that level next Friday. This is the equivalent of buying YHOO at $12.55 per share ($13 minus the $0.45 premium from selling the put option).
This trade is profitable as long as YHOO closes above $12.55 per share next Friday. It closed yesterday at $13.39.
In other words, you'll make money on this trade if YHOO goes up... if it stays the same... and even if it falls a bit. In fact, the only way you'll lose money on this position is if YHOO drops below $12.55 – a decline of 6% – by next Friday.
Of course, you only want to sell puts on stocks you'd like to buy anyway. After all, if the market drops significantly, you'll end up buying the shares. But, you'll get paid handsomely upfront by agreeing to do so.
Check with your broker before you try to do this the first time. Brokerage firms have varying requirements for selling put options.
This is one of my favorite strategies. And with put premiums as high as they are right now, the next week may be the most profitable week of your trading career.
Best regards and good trading,
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