I talk about many different money-making strategies regularly, and among this is selling option premium. This is one of the best and simplest ways to earn income, it can also allow you to get into a stock position at a lower price. Next week offers a particularly good chance to get some positions working, as there are only 3 1/2 days of market action (Wed is a half day, Thur markets are closed for Christmas Day). This is very similar to the market schedule during Thanksgiving week. In fact, this is the third instance this year where there have been 3 1/2 days of real time hours for markets, and all of them have been great times to sell premium.
Now, usually we have a crush on volatility leading up to these short weeks, traders taking advantage and front-running the sellers. In fact, before Thanksgiving they crushed volatility, dropping it to 12% just before the holiday. Currently however, the VIX had such a dramatic run higher this month we are faced with an elevated level leading into Christmas. Volatility surged more than 100%, from about 12% to 24% in a matter of days. That is a hot move and quite rare, but we’ve seen these moves frequently in 2014.
Yet, when the panic settles in and it seems as if everyone is going to head for the exits, the markets turn sharply and quickly. Fear gauges reached high levels this week as the markets only corrected about 5%, but that has been a normal-sized drop this year (save for October, which was about 9%). The VIX index is showing a spike peak with some followthrough to the downside (see chart). However, the gauge stopped on Friday at a support level (50 ma). The MACD is about the produce a major crossover downward, which will be a sell signal for the VIX (buy signal for the markets). It appears the ‘higher low’s trendline comes in around 12.60 or so, where we would consider taking some protection. Dropping VIX might be just what the Santa Claus Rally needs.
So, as I like to wait for a signal and confirmation, we have it here. The next step – trade setup. As volatility may now be in a downtrend the most ideal trade is selling option premium, and again with the holidays upcoming there is a benefit of added decay. To remind you, a premium seller uses the clock to his advantage, selling puts (bullish) or calls (bearish) before expiration. The hope is the options expire worthless at the end of the option’s life.
Ideally, we would be selling puts and calls BEFORE this coming Wednesday, letting the time decay work for us. There is no certainty here of course but when you sell time you have to be disciplined to stay with the trade. Between entry and expiration (usually a Friday on the closing bell) there are many things that can happen, but if we’re confident the trade will work then why not stay with it up until the end and collect the maximum?
Some want to take advantage of the falling volatility to get into stocks they want at a cheaper price. Selling option premium in puts is the strategy here. Say a stock like COP is trading at 71 after being beaten by the drop in crude. Yet, you think it can correct more and would like to buy 300 shares at 65 or so. What you could do is sell three at the money (70 strike) puts, maybe 2-3 months out and take in the premium (try and get 5-6 bucks worth). If the stock falls, the premium you collected collapses. If at expiration the stock is under 70 then you will have it ‘put to you’ at that price, but coupled with the premium you collected your cost is reduced. This is a great strategy for those who are patient. I have more on this strategy here.
Happy holidays to all, and thanks to the bears pumping up volatility we have a chance to sell something this week and win. The Santa Claus Rally technically would start on Dec 24 and last through Jan 5. Let’s see if it materializes.
Bob Lang is a private trader in equity and option markets at his company, Aztec Capital LLC, and an options trader mentor through his education-focused subscription service,Explosive Options. He is the author of popular, strategy-focusedebooks on options trading, one of Jim Cramer’s go-to technical experts on Mad Money and a regular contributor toTheStreet.com. You can find him on Twitter@aztecs99.
