A Major Market Correction’s Coming – Here’s How to Prepare

August 1, 2017

According to a recent CNBC Fed Survey of economists, fund managers, and analysts, a significant correction is coming – and Wall Street is bracing for impact.

Now keep in mind… some of these people have been warning of a major crash since as far back as Election Day. And the Dow, NASDAQ, and S&P 500 made new record highs again earlier in the week.

But real volatility (not the VIX) is rising, which indicates the potential for some kind of pullback – whether small or large – in the coming days or weeks.

So you need to be prepared.

And this is the best way to exploit falling markets…

The Power of the Put in a Stock Market Crash

There’s two solid strategies you can use when the markets fall: a long put or a put debit spread. They’re both extremely powerful in the event of a market crash – and they’re both extremely easy to use.

Let me show you by using a case study on The Clorox Company (CLX)…

CLX reports earnings before market open (BMO) on Thursday, August 3. Judging by the last four earnings sessions and the performance of the stock over the four days prior to the announcements, CLX has traded down for an average move of 1.5% in the three of the last four quarters. That tells us that there’s a greater likelihood of the stock falling again before Thursday, which is why a put or put spread are your best considerations.

Below is an example of a long put on the stock using a CLX August 18, 2017 $135 Put:

And this is an example of a put debit spread using a CLX August 18, 2017 $135 put and a CLX August 18, 2017 $130 put:

Both of these trade ideas will turn a profit when the price of the stock goes down. But here’s the difference…

The long put costs $3.03 (or $303 since one contract equals 100 shares), which is a little more than the debit spread. This is because you are only buying one option instead of selling another option with the same expiration, but at a different strike price, to offset the cost of the long put. Now this is the disadvantage of the put, but the tradeoff is your substantial upside profitability, with the possibility of CLX trading down to zero (albeit extremely unlikely).

The put debit spread costs less, at $2.03 (or $203) per contract which is what you bought the put for, offset by what you sold the other put for. And if you look at cost as risk, the maximum risk in this trade is less than that of the long put. That means you have less risk and, therefore, less profit potential. With the long put, CLX can drop to zero – putting you all that many points in the money, which could be reflected in the price of the options.

With the put debit spread, the most you can make is the difference between the strike prices ($5.00 or $500 per contract), which is offset by the cost of the trade ($2.03 or $203). This makes the most you can make on this trade even – if CLX dropped to zero – is $2.97 or $297 per contract.

But that’s still gives you a 146% profit. And in order to realize that profit, CLX must be trading under the strike price of the option you sold ($130) at expiration so that the markets exercise the right to sell you the stock for $130. When that happens, you can exercise your right to sell it at $135 – giving you that $500 difference offset by the $203 price per contract.

Ultimately, a put debit spread could cause you to sacrifice some upside earnings potential, but you’ve got a higher probability of success on the trade than simply buying a put. In the case of a put, you won’t be sacrificing that upside earnings potential, but you are sacrificing the lower cost.

No matter what you choose, you’ve got a surefire way to make some money if and when the markets crash.

Of course, the trades I used above are not actual recommendations. So be sure to speak with your broker before employing either strategy.

To your continued success…

Tom Gentile

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Source: Power Profit Trades