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Is this the beginning of an even larger bull rally or is this the end of a bear rally? Or could this be the start of a long sideways move, creating a lengthy period of 'wait and see,' until a clear catalyst can get the market moving convincingly in one direction or another?
I'm sure these questions are asked by millions of people everyday.
And while it would be great to know what THE answer is, it may not be all that necessary to make money in the market, especially if you're an options investor.
Know Your Options
While it's important to plan for the inevitable market rebound (the market won't go down or sideways forever), not all stocks are created equal. Regardless of the overall market direction, some stocks will go up, some will go down and some will just go sideways.
And that's perfectly alright.
With options, you can take advantage of all of these scenarios.
Buying Calls and Buying Puts
Buying calls and buying puts is one of the most common ways investors trade options.
If you believe the price of a stock will go up, you can buy a call option on it and make money as it goes higher.
If you believe the price of a stock will go down, you can buy a put option on it and make money as the price goes lower.
Buying options also provides great benefits too such as increased leverage and limited risk.
For instance, buying $100 shares of a $90 stock would require a $9,000 investment.
But instead, you might be able to buy a $90 call option for $8 (which means $8 x 100 shares or $800). That's a significantly smaller investment with a guaranteed limited risk.
If, for example, the price of the stock fell $20 to now $70 a share, your stock investment would have lost $2,000.
However, at expiration, the maximum you could lose on your option investment would be $800 (plus your commission and fees).
The option gives you great upside as well.
A $20 move up in the stock price to $110 would mean a $2,000 increase in your stock investment.
However at expiration, that $90 call option would be $20 'in-the-money' and be worth $2,000.
$2,000 less your $800 premium is a $1,200 profit, or a 150% gain.
The $2,000 gain on your $9,000 investment represents just a 22% gain.
Now let me say that options aren't a panacea. Too many people use options recklessly by loading up on cheap out of the money options that ultimately expire worthless. And even though they have a limited risk (limited to what you put in), if you put everything in there, you run the risk of losing it all.
But smart options trading in my opinion has a respectable place in one's portfolio.
And only invest in an option what you absolutely can afford and would be 'willing' to lose if your assumptions on the market are incorrect.
A put option works the same way except you're profiting if the market goes down.
And buying puts is a great alternative to short-selling.
Covered Call Writing
Covered call writing is an excellent strategy to use in both up, down and sideways markets.
This is a strategy used to reduce risk and generate income.
In fact, you can even execute a strategy like this in many retirement accounts.
Writing an option is different than buying an option in that you're collecting premium instead of purchasing it. Someone else is buying the right to own 100 shares of a stock at a certain price within a certain period of time. If the option expires worthless, the buyer of the option loses what he paid for it, but the writer of the option profits that amount.
For a covered call strategy, this is who we're going to be -- the writer.
For example: let's say you have 100 shares of a stock at $110 for instance. For every dollar that stock goes up or down, your investment will increase or decrease by $100.
Now let's say you wrote the November $125 calls at $6.50 - you stand to collect $650.
With me so far?
If that stock were to go down $6.50 to $103.50, between when you wrote the option and expiration, you've just offset $6.50 or $650 worth of your downside risk.
Because while the stock went down, the premium you collected on the option offset it.
If you're worried about downside risk in your stocks, this is a great way to hedge your investment and potentially make money at the same time.
Now let's say your stock stays flat. It doesn't go up or down. Just stays at $110. You haven't made anything or lost anything on that stock. But at expiration, that $125 call option you wrote for $650 would expire and you would have made $650 even though the stock didn't budge.
If the market enters into a period of sideways action, this is a great way to generate returns if your stocks are stuck in a sideways pattern as well.
Now let's say your stock goes up instead. It rallies all the way up to $125. That's even better. You've just made $15 on your stock or $1,500. And at expiration, that $125 call you wrote will expire worthless and you'll pocket $650. Your grand total is now a $21.50 gain or $2,150 on a $15 move.
Even if the market goes up, you can profit on the stock's movement and the option's income.
Lastly, if the stock rallies past $125 - let's say to $131.50 for example - you're now giving up some of your profit potential. If the stock went from $110 to $131.50, that's a $21.50 move or $2,150 gain. However, at expiration, that $125 call obligates you to deliver that stock at $125 even though it's at $131.50, thus shutting you out of gains above your strike price of $125. You could also buy the option back instead of giving up your stock. But it'd be for the difference between $125 and the current price, which still results in capped gains.
Sometimes this will happen. But stocks don't always go straight up. And while sometimes you may lose out on some upside potential, you'll likely find yourself consistently collecting premiums on your covered calls over and over again.
Put Option Writing
Another great option strategy is put option writing.
Writing puts lets you collect premiums like writing the calls did. But you can potentially get into a stock you'd like to own at a much cheaper price and get paid in the meantime while you wait.
(Although, you will need full option privileges to do this in your account. So check with your brokerage to see if you qualify.)
As you know, if you buy a put option, you're buying the right to sell a stock at a certain price within a certain period of time. The buyer pays a premium for this right. He has limited risk - which is limited to the price he paid for the option.
However, as you know, the writer is taking the other side. He's obligated to buy the stock at a certain price within a certain period of time. But as the writer, he collects a premium.
We're going to be the option writer.
The benefits are: if you write an out-of-the-money option on a stock you wouldn't mind owning if it went down, you might just get the chance to own it at a cheaper price than it's currently trading at if it does go down.
If however, it never gets to that level, you've collected the premium for writing the option and taking the risk that the stock would be put to you at that price.
But again, if you didn't mind owning it if it went lower, you've still won because now you've got that stock at a better price.
For example, if there's a stock you'd like to own, but at a cheaper price, you might decide to write a put option on it. Let's say the stock was at $110 and you wrote the $95 put option for a premium of $6.00 or $600.
If the stock never goes down to $95 by option expiration, you won't get to buy the stock at $95, but you profited $600 for your wait.
Now let's say it does go down to $95 this time. If it does, the option could be exercised and the stock put to you at $95 a share. But you win again because you now have the stock at the price you wanted and you still made $600 on the option while you waited for the stock to get to your price.
(If you didn't want to buy the stock, you could always buy the option back beforehand, which would then remove your obligation to the stock.)
This time, let's say it goes down to $85. You'd now be obligated to buy that stock at $95 even though it's selling at $85.
So you're now down -$1,000 on the stock that was put to you. But you also collected $600 premium for writing that put option in the first place. So your capital loss on owning that stock at $95 is currently -$1,000, but this is offset by the $600 premium that you took in for a net loss of only -$400 for owning that stock at $95.
This is a better deal than simply putting in a buy stop on that stock you were interested in owning, because if your buy stop did get triggered, you would've gotten your stock at $95 but you would not have gotten any offsetting premium that you could have gotten for writing a put.
Your capital loss in this case would be -$1,000 as opposed to only -$400 for writing the put option in the above example.
Put option writing is a great way to collect premiums and generate income while you wait to buy stocks you like at a cheaper price.
Of course, you don't have to want to own the stock to use this strategy. If you have a belief that a certain stock simply won't go down below a certain price, writing a put option is one way to make money, especially if you believe there's more upside risk than down.
As you can see, there are many different ways to make money in options.
And these are just some of the many different options strategies that you can use to make money in the market no matter what.
And there are many, many more:
Take the appropriate amount of time to research each one of these before you attempt to place one on your own.
But my three favorite options strategies are the ones I just described, ...
...buying calls and puts, writing covered calls and put option writing.
And keep in mind, when you're considering these different options strategies, remember to consider their Zacks Rank.
The Zacks Rank 1's and 2's are Strong Buys and Buys, the 4's and 5's are Sells and Strong Sells. The 3's are Holds or Market Perform.
If you're expecting a Zacks #1 Rank stock to blast off, you probably shouldn't be writing a call against your long stock position.
And you may not want to be in such a hurry to write a put option on a stock that's just been ranked a 4 or a 5. You might want to give it some time to see if it'll go any lower first.
But use these different options strategies as yet another set of tools to gain an advantage over the market, regardless of what it's doing. As you can see, there's many ways to profit whether the market is going up, down or sideways.
Here's three optionable stocks with a Zacks #1 Rank ("strong buy"), a Zacks #3 Rank ("hold") and a Zacks #5 Rank ("strong sell").
Alliant Techsystems, Inc. ( ATK - Analyst Report ) is a Zacks #1 Rank or Strong Buy. They are an aerospace and defense company with leading market positions in munitions, smart weapons and precision capabilities. Buying Calls or Writing Puts could be two great trading considerations when analyzing this stock.
International Business Machines Corp. ( IBM - Analyst Report ) is a Zacks #3 Rank or Hold. IBM is a global information and technology company. Covered Calls or Writing Puts would be appropriate strategies to consider for Zacks Rank 3's, especially if you currently own the stock or wouldn't mind getting in, but at a cheaper price.
Aon Corporation ( ) is a Zacks #5 Rank or Strong Sell. They're a holding company whose operating subsidiaries do business in three distinct segments: insurance brokerage, consulting and insurance underwriting. Buying Puts makes sense if you expect more downside action. Or even Covered Calls if you own it and want to offset some downside risk. You might even consider Uncovered Calls too.
Regardless of the market, there's a strategy for virtually anything.
Start learning more and see how you can create you own personal portfolio rebound, with or without the market's help.
Kevin's one of our foremost research experts at Zacks, and today he's prepared to share his personal-favorite options strategies with you.
They're clearly detailed in his new Special Report, 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). In fact, he recently used one of them to make +98.7% in less than 5 months.
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