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We’re always looking for ways to reduce risk in our portfolios while not sacrificing return potential. Incorporating ETFs into our process is a great way to do just that.
The Zacks Finance sector is currently ranked #1 out of 16 total sectors and contains many leading financial industries including banks, exchanges, and insurance. Stocks in these industries have been outperforming this year.
These stocks are showing several promising characteristics including relative undervaluation and above-average projected earnings growth:
Image Source: Zacks Investment Research
Historical research studies suggest that approximately half of a stock’s price appreciation is due to its sector and industry group combination. In fact, the top 50% of Zacks Ranked Industries outperforms the bottom 50% by a factor of more than 2 to 1.
It’s no secret that investing in stocks that are part of leading sectors and industry groups can give us a leg up relative to the market. By focusing on leading stocks within the top industries, we can dramatically improve our stock-picking success.
The Direxion Daily Financial Bull 3X Shares ETF (FAS - Free Report) is in a sustained uptrend and provides us with exposure to the Zacks Finance sector. This ETF offers daily investment results that correspond, before fees and expenses, to 300% of the performance of the Financial Select Sector TR index.
Image Source: StockCharts
Option Essentials
While there are many ways to take advantage of a bullish move in the FAS ETF, options provide us with flexibility, enabling us to tailor our strategy to the current market environment.
When done correctly, trading options provides huge profit opportunities with limited risk making options one of the most versatile investment vehicles.
Before we analyze today’s trade, let’s review some option fundamentals as a refresher. There is no need to worry about complex mathematical formulas or equations. Over the years I’ve found that the more complicated a strategy is, the less likely it is to work over the long run.
Options are standardized contracts that give the buyer the right – but not the obligation – to buy or sell the underlying stock at a fixed price, which is known as the strike price. A call option gives the buyer the right to buy a particular security, while a put option gives the buyer the right to sell the same. The investor who purchases an option, whether a put or call, is the option buyer, while the investor who sells a put or call is the seller or writer.
These contracts are valid for a specific period of time which ends on expiration day. There are weekly options, monthly options, and even LEAPS options which are longer-term options that have an expiration date of greater than one year.
Option spreads can be an extremely effective strategy. Debit spreads are implemented by purchasing a call option and selling a related call option with a higher strike price. These types of trades are limited risk trades because the short option is ‘covered’ by the option purchase.
Below we’re going to explore a call option spread strategy.
The Power of Option Spreads
The FAS ETF is making a series of higher highs and currently meets our criteria for initiating a bullish call option spread position.
The table below displays the risk/reward profile for this trade. FAS is trading at $180.65 at the time of this writing. This trade involves purchasing the October 155-strike call at 27.75 points (yellow box), and selling the October 175-strike call at 12.2 points (orange box) for a total cost of 15.55 points. As option contracts represent 100 shares of the underlying security, this would translate to a total cost of just $1,555 per spread (brown box).
Image Source: Zacks Investment Research
The top (blue) row in the lower section shows the performance of FAS based on different percentage scenarios at expiration. The last (purple) row shows the corresponding percentage return for our debit spread trade. We can see that regardless of whether FAS increases in price, remains flat, or even loses -2.5% from our entry, our option spread trade will produce a 28.6% return in one month.
These are types of odds I like to have in my favor when trading options.
Advantages of Spread Trading
1) The Option Sale Provides Downside Protection
The sale of a call option results in cash being credited to your brokerage account. This reduces the cost basis of the option purchase and provides downside protection in the event the price of the underlying stock declines.
2) Risk is Reduced
In the FAS trade just presented, the sale of the 175-strike call reduced the risk of the 155-strike purchase from $2,775 to just $1,555 per contract.
3) Allows Us to Maintain Positions During Volatile Markets
The downside protection provided by the call option sale helps us maintain our spread trade during heightened volatility. Naked option purchases may force us to sell early in order to prevent large losses.
4) Spreads Can Be Profitable If Stock Goes Up or Down
Option spreads can be profitable even if the underlying stock decreases or remains flat, providing us with an entirely new dimension of money-making opportunities.
Remember that the call option sold through this strategy profits as the price of the underlying stock declines, providing us with a cushion during market pullbacks.
Option spreads are a safe way to use the leverage inherent in options. Your risk is limited to the price paid for the spread. The call option spread strategy is an excellent way to take advantage of the bullish move in FAS as the ETF looks primed to continue its uptrend.
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Weekly Option Windfall: Financial ETF Offers 29% Return Potential in 1 Month
We’re always looking for ways to reduce risk in our portfolios while not sacrificing return potential. Incorporating ETFs into our process is a great way to do just that.
The Zacks Finance sector is currently ranked #1 out of 16 total sectors and contains many leading financial industries including banks, exchanges, and insurance. Stocks in these industries have been outperforming this year.
These stocks are showing several promising characteristics including relative undervaluation and above-average projected earnings growth:
Image Source: Zacks Investment Research
Historical research studies suggest that approximately half of a stock’s price appreciation is due to its sector and industry group combination. In fact, the top 50% of Zacks Ranked Industries outperforms the bottom 50% by a factor of more than 2 to 1.
It’s no secret that investing in stocks that are part of leading sectors and industry groups can give us a leg up relative to the market. By focusing on leading stocks within the top industries, we can dramatically improve our stock-picking success.
The Direxion Daily Financial Bull 3X Shares ETF (FAS - Free Report) is in a sustained uptrend and provides us with exposure to the Zacks Finance sector. This ETF offers daily investment results that correspond, before fees and expenses, to 300% of the performance of the Financial Select Sector TR index.
Image Source: StockCharts
Option Essentials
While there are many ways to take advantage of a bullish move in the FAS ETF, options provide us with flexibility, enabling us to tailor our strategy to the current market environment.
When done correctly, trading options provides huge profit opportunities with limited risk making options one of the most versatile investment vehicles.
Before we analyze today’s trade, let’s review some option fundamentals as a refresher. There is no need to worry about complex mathematical formulas or equations. Over the years I’ve found that the more complicated a strategy is, the less likely it is to work over the long run.
Options are standardized contracts that give the buyer the right – but not the obligation – to buy or sell the underlying stock at a fixed price, which is known as the strike price. A call option gives the buyer the right to buy a particular security, while a put option gives the buyer the right to sell the same. The investor who purchases an option, whether a put or call, is the option buyer, while the investor who sells a put or call is the seller or writer.
These contracts are valid for a specific period of time which ends on expiration day. There are weekly options, monthly options, and even LEAPS options which are longer-term options that have an expiration date of greater than one year.
Option spreads can be an extremely effective strategy. Debit spreads are implemented by purchasing a call option and selling a related call option with a higher strike price. These types of trades are limited risk trades because the short option is ‘covered’ by the option purchase.
Below we’re going to explore a call option spread strategy.
The Power of Option Spreads
The FAS ETF is making a series of higher highs and currently meets our criteria for initiating a bullish call option spread position.
The table below displays the risk/reward profile for this trade. FAS is trading at $180.65 at the time of this writing. This trade involves purchasing the October 155-strike call at 27.75 points (yellow box), and selling the October 175-strike call at 12.2 points (orange box) for a total cost of 15.55 points. As option contracts represent 100 shares of the underlying security, this would translate to a total cost of just $1,555 per spread (brown box).
Image Source: Zacks Investment Research
The top (blue) row in the lower section shows the performance of FAS based on different percentage scenarios at expiration. The last (purple) row shows the corresponding percentage return for our debit spread trade. We can see that regardless of whether FAS increases in price, remains flat, or even loses -2.5% from our entry, our option spread trade will produce a 28.6% return in one month.
These are types of odds I like to have in my favor when trading options.
Advantages of Spread Trading
1) The Option Sale Provides Downside Protection
The sale of a call option results in cash being credited to your brokerage account. This reduces the cost basis of the option purchase and provides downside protection in the event the price of the underlying stock declines.
2) Risk is Reduced
In the FAS trade just presented, the sale of the 175-strike call reduced the risk of the 155-strike purchase from $2,775 to just $1,555 per contract.
3) Allows Us to Maintain Positions During Volatile Markets
The downside protection provided by the call option sale helps us maintain our spread trade during heightened volatility. Naked option purchases may force us to sell early in order to prevent large losses.
4) Spreads Can Be Profitable If Stock Goes Up or Down
Option spreads can be profitable even if the underlying stock decreases or remains flat, providing us with an entirely new dimension of money-making opportunities.
Remember that the call option sold through this strategy profits as the price of the underlying stock declines, providing us with a cushion during market pullbacks.
Option spreads are a safe way to use the leverage inherent in options. Your risk is limited to the price paid for the spread. The call option spread strategy is an excellent way to take advantage of the bullish move in FAS as the ETF looks primed to continue its uptrend.