One of the well known investment periodicals has an article questioning how far one can trust that the recent stock market rally is real. For the trader it may not make a difference so long as you trade market moves or you hedge your medium term bets with options trading.
The New York Stock Exchange made its best five week rally in over seventy years. The rally was capped with the announcements of record profits by Wells Fargo which got everyone all excited about bank stocks.
The thing is that people are, in fact, betting on a recovery. As the evidence strengthens the market will move higher, again. These market advances will be tempered with profit taking every time. Also, any bad news will drive the market back. However, assuming that this recession, like all of them, will eventually end, the time will come when everyone will rush in and the market will surge even higher. The problem is judging when.
That is the point of options trading in calls. You pay a premium to place a call order on a Wells Fargo or Citigroup. In options trading, if the stock does not go up, you only lose the premium you paid for the call. If the stock jumps past your strike price then you have two options, so to speak. The first is to go ahead and execute the call, sell the stock, and take your profit. The other is simply to sell the call option when it becomes more valuable.
If you are betting on the down side and believe that market has gone too high on JPMorgan, Bank of America or any of the bank stocks subject to speculation today you can use options trading to buy a put (at slightly below the current price, let’s say). In options trading in this instance you are expecting that the stock price will drop precipitously. If so, as with options trading in calls, there are two things you can do. You can exercise the put option, buy at the now much lower price, and pocket your profit. Or, you can sell your, nor more valuable, put option and take your money.
Whereas long term investors protect long positions by buying puts in the same stock they hold the point of options trading with puts for the short term investor is to cash in on moves by bank stocks, for example, without buying or selling entire blocks of stock.
Everyone believes that the market is coming back and no one is sure when. With extreme market volatility this indecision can cause the value of a given option to fluctuate widely. The trader who buys a low priced option, either call or put, can sell in a few days at a substantial profit, wait for the market to recycle and do it again.
The same principles apply to options trading as to all aspects of day trading. Know the stocks or markets you are trading in. Continually buying calls when the stocks are going down or puts when they are going up will tell you that you jumped the gun or did not do your homework. Stay cool, focus on your part of the market, your stocks, and make a little money in options trading in calls and puts as the market recovers in fits and starts.
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