Ever wonder what your trading experience might be without attempting to time every entry and exit point? Do you find yourself pulling out clumps of hair in spats of frustration and aggravation? If so, it might be time for a conversion to option selling.
One of my favorite option strategies is selling put options on large blue chip companies that have just reported earnings. Like many option traders, I am tired of trying to predict where a stock will go after an earnings announcement. I would prefer to trade stocks that are stable and less likely to make major corrections. Moreover, it just feels easier and more natural to trade periods of twenty to forty days rather than hours, or minutes.
Selling put options is a very simple neutral-to-bullish strategy. One stands to profit if the underlying stocks increase in value or moves sideways. If however the stock falls, the writer of a put option is obligated to purchase the underlying stock at the strike price. For accepting this risk a trader receives a premium. If the underling stock advances, the option expires worthless and a trader keeps the premium received. (See the profit/loss chart below).
Finding stocks to trade is quite simple using the Zacks Research Wizard. I simply scan for stocks that belong to the SP100, and I remove those that report earnings within the next thirty days. I then glance at the charts to verify a stock is not downward trending and I quickly read the news headlines. I try to avoid companies that have posted recent news event such as mergers, lawsuits, or accounting irregularities. I also avoid stocks that are experiencing high levels of volatility. For instance, I'll remove stocks that have moved (+/-) 15% with the last quarter, (+/-) 10% in the last month, and (+/-) 5% in the past week.
Next I'll quickly calculate the return on investment for each stock and select those that yield a minimum return of 3%. Return on investment (ROI) is calculated as follows:
Strike Price: - $50
Stock Price: - $52.50
Option Premium: - $1.00
Maximum Risk/Break Even: - $50 - $1 = $49
Maximum Reward: - $1.00
ROI: - $1 / $49 = 2%
I'll generally pick an option contract that is one strike price out-of-the-money, i.e., those with a delta near .30 or 30%. That will give my trade a 70% chance of success. (For those of you that are new to option Greeks, you may want to call one of our coaches for an explanation.) Lastly, I'll enter a buy-to-close stop-loss order to protect myself from a downward spiral in the stock price and I'll check to make sure that I sell options on stocks from a diverse group of industries. The real trick to this strategy is to sell many small positions that span the entire universe of stocks.
Want to apply this winning option strategy and others to your trading? Then be sure to check to check out our Zacks Options Trader service.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.