Easy-to-Find Option Trades That Work
04/24/2012 7:00 am EST
Positive-Delta option trades are highly appealing in today’s market conditions, writes Dan Passarelli, identifying important risk factors as well as three stocks that make compelling targets right now.
Do you feel like you’ve seen this market movie before: trouble in Europe, especially in Spain; people in the streets; and panic in the markets? Is this recent wave of trouble going to last forever?
Not likely, and perhaps there is an opportunity to fade this fall. But how should an option trader play the fade to maximize chances of success and maximize option returns? Trade ideas like this are discussed weekly in the MTE newsletter.
The obvious starting point for a trader to fade this fall is to take a positive-Delta position. Simply, Delta is a number that measures how much the theoretical value of an option will change if the underlying stock moves up or down by $1.00. Positive Delta means that the option position will rise in value if the stock price rises and would drop in value if the stock price falls.
See also: Delta: The King of All Option Greeks
This is fancy options speak for a bullish trade. There are lots of different ways to take a bullish stance given all the various types of option strategies out there. So, the question really is, which is best?
There are a few major considerations here. First, traders must strive to maximize reward by minimizing risk. In order to do so, option traders must define their expectations. Am I looking for an extreme turnaround, a mild retracement, or even a dead-cat bounce? The more a strategy can be tailored to expectations, the more risk can be controlled and reward can be maximized.
Next, traders need to consider implied volatility. This is where option traders can get an edge in their options positions. If implied volatility is high (overpriced), option traders should consider option-selling strategies. If implied volatility is low (underpriced), option traders should consider option-buying strategies.
See related: Option Volatility Made Easy
In the current market scenario, we have a situation where if the turmoil in the Europe and Spain subsides, the market should rally somewhat, but it’s not likely to go to the moon. Further, with the levels and implied volatility of individual stocks at inflated levels, it’s easy to find overpriced options.
Any clever fade trader should be looking for put credit spreads to sell. Put credit spreads have positive Delta and take a short position on implied volatility.
Great candidates for this sort of play are Apple, Inc. (AAPL), Google (GOOG), and Priceline (PCLN). Traders are best off staying away from bank stocks and precious metals that might be adversely affected by European instability.
By Dan Passarelli of MarketTaker.com
Which options would you buy or sell to get positive Delta? Let us know in the comments area below.