In December, I predicted that volatility would make 2016 a “trader’s year,” where buy-and-hold investors would get hammered while nimble, aggressive traders would reap huge gains.
Last week, the markets proved me right in a big way. Out and out panic is starting to show, spurred by Middle Eastern tensions, plunging markets in China, and worries about global growth.
Remember: If you’re trading, this is a great time to be in the market.
There are bargains all over, and, even better, the short, sharp market action means options plays can bring in huge returns in short order.
In fact, we just doubled our money on a pattern that developed as the market was tanking.
With these markets, we’re likely to see this pattern again soon, so let’s look at how we can make money on it…
This Concept Had a Lot to Do with Our “WYNN”
Before we look at the profitable pattern that played out with Wynn Resorts Ltd. (Nasdaq: WYNN), I’d like to show you an important concept that played a big role in this 100% gain: implied volatility (IV).
The basic principle of IV is that the higher it is, the higher the option’s premium will be. It helps options traders because they can generally determine if an option is too expensive based on how high the IV is.
IV lets you see the market’s view on the potential move in the stock. A high IV means the markets are expecting a big move in either direction by an option’s expiration date. A low IV means the markets are expecting a smaller move in either direction by an option’s expiration date.
Now I have to stress that IV does not actually forecast direction; rather, it forecasts the magnitude of the direction a stock will move.
Typically, you would want to buy an option with a low IV. The anticipation here is that once the IV starts increasing, it will account for any rise in the option’s premium along with any intrinsic value that may come with it.
Now keep in mind that there is the chance that once you’ve entered a trade, the stock’s IV could start declining. If the IV alone was too high to begin with, then this could result in a depreciation of the premium. It is in this situation that you’d want the price to move further “in the money” (ITM), which would offset the drop in IV by adding to the intrinsic value.
IV can provide you with or remove your existing conviction to trade, so there are three ways to go when considering IV:
- You can avoid options with high IV;
- You can hedge an option with high IV that you’ve already bought by adding another option against it, like in a spread trade; or
- You can find patterns where IV isn’t a factor.
And No. 3 on that list is exactly what I did using my Money Calendar.
How This Pattern Doubled Our Money
My Money Calendar crunches hundreds of millions of data points and shows which stocks have made an upward or downward move 90% (9 out of the last 10 years) of the time over the last 10 years analyzed. It then calculates the average profit or price move it made out of those years. IV is not a factor in producing that average price move.
Once I have that information, I work on the premise that, if this stock made an average five-point move 90% of the time, I should build an option trade on it using that five-point move as my goal for the trade. Then I look for an option that has a chance to double with that price move.
And I found one…
Wynn Resorts Ltd. had an average expected price move of six points.
So here’s the trade that I gave my Money Calendar subscribers:
Entry Date: Dec. 14, 2015
BUY-to-Open: Wynn Resorts Ltd. (Nasdaq: WYNN) WYNN January 8, 2016 $65 Call (WYNN160108C00065000) for $3.50 or less
Exit Date: Jan. 6, 2016
SELL-to-Close: Wynn Resorts Ltd. (Nasdaq: WYNN) WYNN January 8, 2016 $65 Call (WYNN160108C00065000) for a 100% return
I chose Wynn because I considered it a value play. In March 2015, the price ranged around $130, but at the time of the trade, the price range hovered around $65 to $70, which is of course roughly half of what it was.
I think Wynn makes a good Contrarian play, because while the bears were trying to drive the price range lower, there seemed to be enough buying happening to keep it at this range.
Furthermore, I anticipated that the casinos would be getting a good push in mid-December through the first week or so of January.
Although the IV was high at the start of the trade, this is one of those times when my Money Calendar found a pattern – regardless of IV. Now, with that said, I’m not trying to diminish the importance of IV, because a low IV to begin with could have added to the trade’s profitability.
I expected WYNN to make a six-point move to the upside, but it actually moved a bit higher, and the option trade that we entered at $3.50 hit $7 before I closed it out – a welcome surprise, and an easy double… on the very day the market plunged into free fall.
The trade worked perfectly, and I’m always looking for more trades based on the patterns and setups that my Money Calendar gives me.
— Tom Gentile
Source: Money Morning