Hey there, VWAP Legion!
Well – did I tell ya, or did I tell ya?
The market goes nuts when I’m away from my trading desk, as you’ve witnessed this week.
I warned Money Morning Live folks on Tuesday…
Thankfully, because I trade the only indicator you’ll ever need (that would be VWAP, for the slower kids), I can make money on both the bullish AND bearish side.
If you know the ins and outs of my VWAP strategy (and those who don’t yet will), today was by far the greatest day EVER to be a VWAP trader.
The gap down today presented opportunities seen maybe 10 times a year, and the Dip & Rip trade was as abundant as ever.
There were obviously lots of opportunities on the short side of the trade, too – IF you know what you’re doing.
In fact, yesterday I explained the basics of short selling, which is one way (albeit risky!) to play a stock’s move into the red…
Today, and ahead of an onslaught of earnings reports next week, I’m gonna show you another way traders can place bearish bets – this time with LIMITED risk…
We’re going to discuss the ABCs of buying put options, and some of the “rules” I follow during earnings season.
What Are Put Options?
For those of you new to the options game, let me break it down in the simplest terms possible.
There are two types of options: Calls and puts.
There are about a billion different strategies you can do with these options, but for simplicity’s sake, we’re going to talk about straight-up “vanilla” buying today.
In a nutshell, a trader will buy a call if they think the underlying stock is going higher, and will buy a put if they think the underlying stock is going lower.
When selecting which option to buy, the trader must consider a couple things, both of which will be reflected in the option’s price (which also represents the maximum risk):
- The strike price: This is the “line in the sand,” so to speak. A call buyer expects the shares to move above the strike price, while a put buyer expects the shares to move below the strike price.
A call is considered “in the money” (ITM) if the underlying stock price is above the strike price, while a put is ITM if the stock price is below the option’s strike.
ITM options will be more expensive than options that are at (ATM) or out of the money (OTM).
So, if fake (but awesome) stock Glick Enterprises (GLIK) was trading at $50, the $52-strike put would be $2 in the money – and that intrinsic value would be reflected in the cost of the contract.
On the other hand, the ATM $50-strike put would cost less than the ITM option, and the OTM $48-strike put would be even cheaper.
- The expiration date: Options expire at the close on Friday. Many stocks have weekly options expiring EVERY Friday, while other less liquid stocks have only standard monthly options (expiring the third Friday of the month).
Time is money, as they say, and options are no exception.
A $50-strike put that expires in two days will cost much less than a $50-strike put expiring in two months.
That’s because you’re buying more time for the underlying shares to make a move in the right direction.
In the best-case scenario for a put buyer, the underlying stock will nosedive below the strike price by expiration, thus increasing the intrinsic value of the put, and the trader can sell to close that option for a profit.
In the worst-case scenario for a put buyer, the underlying stock stays or moves above the strike price, and the trader loses the entire premium paid for the contract.
BUT – that risk is limited, which is more than I can say for selling a stock short.
How The Warlock Uses Puts
So… how might I, Kenny Glick, the greatest trader EVER, use put options around earnings?
Well, there are a few things I might do differently than if I’m simply shorting shares outright.
- I don’t usually buy options before an earnings report.
This is because implied volatility (IV) rises ahead of earnings, due to expectations for a big reaction one way or another.
In the simplest terms, buying options before an earnings report is like buying a car the day before it goes on sale. It’s ALREADY going to depreciate when you drive it off the lot, and now you wanna toss even MORE money into the wind?
STOP IT, BLANCHE.
Instead, I wait until the company’s earnings are released before I begin speculating.
This not only takes the DIRECTIONAL guesswork out of the equation – it also prevents me from overpaying for options contracts (sometimes by 20% to 30%), since IV deflates rapidly after earnings are released.
- I don’t overpay for time I don’t need.
I’m a day trader – I don’t typically buy and hold investments overnight.
So whether I’m speculating with shares or options, I’m looking to get in and out of my trades with a quickness, entering and exiting the same day.
Therefore, I’m usually looking at the options that expire soonest – often weekly options expiring the upcoming Friday.
- I don’t buy deep OTM contracts.
I usually target ATM options, buying around the underlying stock price at the time.
Yes, these are more expensive than OTM options, but they’re more likely to move ITM in time for me to profit on the right side of the VWAP day trade.
Profiting from an OTM option purchase would require a bigger move by the underlying shares in a short time frame – and yes, sometimes that happens and the buyer gets lucky, but most OTM options end up expiring worthless.
That’s all for today, VWAPers, but I’ll be back tomorrow morning – starting at 8:30 a.m. ET on Money Morning Live, followed by an hour of LIVE trading at 9:30 – so make sure you’re there!
We have a lot to catch up on.
Kenny “The Warlock” Glick
3 responses to “Put Options: Another Way to Bet Bearishly”
July 08 2021