Fears over the COVID-19 coronavirus have brought volatility back in a big way. Last week, the CBOE Volatility Index ($VIX) rocketed 88% higher. But don't let that scare you. Volatility means stocks move.
And that means more potential to profit.
We're taking advantage of that by trading options on some of the stocks most affected by the volatility, and we've already bagged gains of 450% and 50% in just a week. We're going to keep going this week.
As most people know, the coronavirus took a major toll on the Chinese economy. Just because there have only been a handful of cases in the United States doesn't mean we are in the clear, at least not economically. As the world's second largest economy, China plays a role in just about every industry. They are essential in supplying labor, parts, and resources. Slowdowns there back up the supply chain for all sorts of goods sold here by American companies, and that, in turn, can hurt earnings.
Without making light of the medical problem around the world, Wall Street's reaction was likely overdone. Yes, stocks deserved to fall, but 12.4% in just one week's time is an overreaction. That seems like a lot of emotion for a predicted recession that so far has failed to materialize.
The bad news is that the volatility is probably not over.
At the same time, the good news is also that the volatility is probably not over.
That gives us even more opportunities to profit...
How to Profit from Volatility
Most investors are familiar with the basic concept of options. Instead of owning a share of stock, they can own the right to buy that stock at a specific price for a small "fee." If they choose to exercise that right, they then put up the money needed buy that stock. The dollar risk is small, but the return can be very large.
That's how we made such big gains on Carnival Corp. (NYSE: CCL). When Money Morning's options trading specialist, Tom Gentile, saw stocks dropping on Feb. 21, he saw an opportunity. Tom recommended buying the April 17, 2020 $40 put on Carnival. The contract traded for just $160 when Tom recommended it. Today, that contract is trading for $880, a 450% gain.
We followed that up with a play on Marathon Oil Corp. (NYSE: MRO). That option jumped 50% higher between Wednesday (Feb. 26) and Friday (Feb. 28).
But now that the daily 1,000-point drops seem to be over, we are switching tactics. While the volatility isn't over, we're just as likely to see stocks bounce higher as they are to fall lower.
If you think a stock is going to make a big move but aren't sure which way it will go, we have the play to make. After all, when the Dow can move 1,000 points in either direction, we can't really be sure which move will be next.
That's why a strategy called a "straddle" could be a good choice.
Options straddles, another popular strategy, means buying both a put and a call on the same stock with the same strike price with the same expiration date. This is a great way to capture a big move on the stock when you don't know which way it will move. For example, in more normal times, you think that the market is completely dialed in to the next earnings release for a company. If it's good, the stock will soar, and if it's bad, the stock will collapse. A straddle lets you profit either way.
But a straddle can be pricey right now. Since part of the price of an option depends on volatility and volatility is sky-high right now, the price of this trade will also be high. It will be a little harder to score that profit. But what we can do is spread the trade out a bit to reduce costs.
One modification to this strategy is called a "strangle," and it achieves the same goal but with a lower cost. Instead of buying at-the-money calls and puts, you buy out-of-the-money options, which cost less. In other words, you buy a call with a higher strike price and a put with a lower strike price.
The trade-off is that you need a bigger move from the stock before this strategy becomes profitable. However, considering the current market environment, that bigger move seems rather likely.
Here's just how to do it...