Today I'm going to examine in granular detail a moneymaking tool called the loophole trade.
First, any discussion of the loophole trade must involve volatility. Over the past few weeks, we've witnessed wild intraday swings in the market. One day it's down a couple hundred points, closing at or near its lows of the day, and the next it rallies back up those 200 points or more, closing at or near its highs for the day. It's enough to give a trader whiplash.
This market volatility can also cause a great deal of volatility in the pricing of options. For traders looking to buy calls or puts, this makes it challenging to obtain profits, if for no other reason than options are more expensive than usual due to this volatility.
So how does one avoid this volatility? One choice is to simply not trade and instead wait until the markets settle down – but that's not acceptable to me. My mission is to make you money regardless of market conditions. I want to play in the game, not sit on the bench.
What's another choice? Consider the loophole trade. Below, I drill down and comprehensibly discuss why certain market conditions would compel me to recommend one so that you can confidently embrace the power of the loophole trade.
The Two Reasons for a Loophole Trade
The loophole trade is a debit spread. It can be either a call credit or a put debit trade.
Here are two reasons to consider the loophole trade:
- The options you are looking to buy have too much implied volatility and are deemed expensive, and/or…
- To hedge a straight call or put option. Creating a loophole trade reduces the cost of a straight option purchase, thereby reducing your risk in the trade.
Have you ever bought an option on a stock and had the stock move in the direction you anticipated and the option barely move at all?
Even if a day goes by and the stock stays at roughly the same price, you should only suffer a bit of theta, or time-value loss. However, if the option was too expensive to begin with, it could lose more in that situation.
About the Author
Tom Gentile is one of the world's foremost authorities on stock, futures and options trading.
With more than 25 years' experience trading stocks, futures, and options, Tom's style of trading systems and strategies are designed to help individual investors propel themselves past 99 percent of the trading crowd.