By: Steve Smith
The past few days have been among the wildest I’ve seen in the market, presenting great opportunities. But this also means being prepared to deal with trades going awry.
I often refer to my Options360 service as taking an “unconstrained” approach to options trading. Meaning, unlike many other stock services with just one strategy, — such as buying options outright, using spreads or stocks to debit or credit positions — my manta’s always been to: “Choose the strategy that best aligns with your thesis.” As an addendum, it also means taking overall market conditions into consideration.
Over the past few days, I’ve taken a distinctive turn towards using credit spreads; they’re now paying me to take risks and also give me a cushion without trying to pick an exact high or low. I’ll share the specifics of a couple of trades below. But first, some macro thoughts. In the wake of a potential COVID-19 vaccine, we’ve seen massive rotation from the big cap stay-at-home tech stocks into the beaten-down travel/leisure/dining sectors. I think the general rebalance or reversion is healthy and warranted. However, at this point, both seem a bit too knee jerky and overdone.
As I wrote in a mid-day Options360 missive today, I wonder if on a macro level, we didn’t “just witness a massive blow off, double top and the ultimate ‘sell the news’ reaction to the news of a vaccine.”
With this as the backdrop, I started scanning for stocks that were up over 20% on Monday and were approaching resistance, or even all-time highs.
The two that jumped out at me were Brinker (EAT) and Planet (PLNT), the former an operator of casual dining mainly under Chili’s brand with the latter being a national gym franchiser — two of the hardest-hit industries. While a vaccine is certainly good news, it’s still unapproved and under ideal circumstances, a year away from being widely distributed. So, in the meantime, both these businesses will remain under constraints and longer-term, may never get back to prior growth or profitability levels as consumer behavior takes a permanent shift to dining and exercising. In both situations, I engaged in selling a bear call spread, which is selling a closer-to-the-money call and buying a further out-of-the-money call. I did this to collect a premium that I’ll keep as profit as long as shares don’t go above the lower strike. For example, here’s part of the EAT Options360 alert that was sent to my exclusive members:
“Brinker (EAT) operates and franchises some 1,700 restaurants with the majority being under the Chili’s brand and about 100 Maggiano’s. I know the possibility of a vaccine is good news but there is no way you can tell me their business, and therefore their stock price, will/should be above pre-covid levels. Using a bear call spread on the notion new highs should not be made in the coming two weeks.”
-Sell to open 3 contracts EAT Nov (11/20) 55 Calls
-Buy to open 3 contracts EAT Nov (11/20) 60 Calls
For a Net Credit of $0.85 (+/-0.05)
Today. EAT shares are down some $3 to $47 and the value of the spread has collapsed. I sent Options360 members an Alert to enter an order to close the position at $0.15, which barring a big reversal higher, should be executed in the next day or two, delivering 85% of the maximum profit potential and a solid 45% return on risk (ROR) in a matter of a day.
On the other hand, I also established a bullish position in PayPal (PYPL) through a 177.5/182.5 bull put spread. With the stock coming under pressure, I took defensive action by making an adjustment of selling the 192.5/197.50 call spread and turning the position into an iron condor. Our risk has now been cut in half and time decay is on our side!
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.
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