Today, I’d like to take it up a notch because we are entering a great time for traders.
The VIX is up big. It’s time to make sophisticated use of fear, while it lasts and bank profits, thanks to it.
Many times in the past, I’ve shown you that one of the ways to generate a steady cash flow from the stock market comes down to insuring other investors and charging a premium for doing so.
This works best when (1) insurance is expensive, which happens at times of higher VIX, and (2) when some of the best stocks on your watch list are cheap.
Back when the FED first revealed its hand in 2010, signaling to investors that they had a friend at the central bank, which would help restore confidence by buying up bonds and propping-up asset prices itself, by lowering bonds yields to zero and even negative rates, the best bet was to go against the crowd and make a giant bet on U.S. equities, though everyone was reluctant to own stocks.
Right now, the FED is, again, telling investors that they want to pull out completely from equities because they are not concerned anymore with the strength and viability of the business cycle.
Investors just got the shivers, but if the FED is correct, we could be entering a “mother of all bull runs” period, similar to the one we enjoyed in the 1950s, the last time interest rates rose from artificially low, back to normal.
In the meantime, until we see the clear direction, fear is opening-up a revenue stream for options traders.
Take a look at a trade I’ll be executing myself:
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Every options contract is comprised of 100 shares, so in this trade, I’ll be selling puts on three contracts. I’m looking at a potential investment of about $10,000 in shares of AT&T.
Come January 18th, or perhaps much sooner, we’ll know how well this put selling transaction is panning out to be.
The way I see it, it’s a major asymmetric bet (low risk, big reward), since I win in any case.
Shareholders of AT&T, a company, who is paying a 6.20% dividend yield and is growing at a 6% likely pace, going forward, dominates its market and has a current P/E ratio, is willing to pay put sellers, right now, $1.44 a share, for their willingness to buy shares off their hands for $32 per share on a strike date in January, 2019.
Said differently, someone, who currently owns AT&T (NYSE:T), fears that his position is going much lower, since he is willing to insure himself against loss, by paying me, a put seller, $1.44 per share, to buy his shares for $32, no matter what their price will be.
Obviously, if the price doesn’t drop, he will not claim on his policy, and I will get to keep my premium, but if the price crashes, I will be forced to pay $32, even if the open market trades far lower than that.
At three contracts, we’re talking 300 shares, so I’ll be pocketing $432 today ($1.44*300), as our contract is electronically created. If all goes well, T shares trade above $30.56 ($32.00-$1.44), and I will walk away with what we refer to as an infinite return, the best kind. I make $432 and invested $0 to generate it.
Now, on the flip side, if the stock does lose big, I will have to pay, in effect, $30.56 for the shares, since I got paid $1.44 and the strike price is $32.00.
That’s fantastic, since I see that as a bargain price to be paying for this company. The reason I only create three contracts is that the total cost would be $30.56 * 300 = $9,168, which will leave me room to purchase more shares on the open market, if the January price is lower, since I have already made up my mind to purchase $20,000 worth of shares.
Volatility is heaven for put sellers. Look at your favorite companies because nervous investors might be handing out gifts as well.
Research Partner, PortfolioWealthGlobal.com
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This work is based on SEC filings, current events, interviews, corporate press releases and what we’ve learned as financial journalists. It may contain errors and you shouldn’t make any investment decision based solely on what you read here. It’s your money and your responsibility. The information herein is not intended to be personal legal or investment advice and may not be appropriate or applicable for all readers. If personal advice is needed, the services of a qualified legal, investment or tax professional should be sought.