Dan Passarelli is an author and the founder of Market Taker Mentoring LLC, the home of personalized, one-on-one options education.
With this down turn in the market, options trading investors have an opportunity to capitalize on what is likely to be your standard market overreaction. With the turmoil in the Middle East, the S&P 500 got beat up pretty bad over the past week. But a lot of individual stocks got hit pretty hard too.
For example, Starbucks, Inc. (NASDAQ: SBUX). It followed suit right along with the broad market (as one might expect), but lost a much greater percentage than the S&P. On the one hand, that is somewhat expected. It has a beta that relates its likely movement relative to the market. SBUX as a beta of around 1.25. That means it (in terms of systematic risk) should move 125% like the S&P 500 (assuming no company-specific news). And, SBUX hasn’t had any major SBUX-specific news to affect it much either way.
In fact, SBUX has lost more than it should have in this recent market down turn. Ya know what that means? Opportunity.
If (and — possibly more appropriate — when) the market turns around SBUX is likely to follow suit, and in turn, gain more than it should. But, here in the optionsphere is a nuance that offers greater opportunity than simply scooping some up at the perceived bottom. Fear means high implied volatility (IV). In other words, options are expensive — another exploitable nuance.
The opportunity here is to sell a put spread. That gives traders bullish directional positioning and a bearish-on-implied-volatility position. That is a potential win-win. The way to milk this trade for all it’s worth is to sell the SBUX March 29-31 Put Spread. That is sell the March 31 Puts, which closed Friday at 32 cents, and buy the March 29s, which closed at 20 cents.
In simple terms, if the stock rises and implied volatility falls, this trade will kill it. But, in fact, SBUX has been a steady stock, lending itself to credit spreads like this for some time. To be sure, even if this little downturn in the broad market didn’t happen, I’d have liked this trade anyway. This recent move just gives traders an opportunity to get an even bigger credit, and an even better risk-reward.
Dan Passarelli of MarketTaker.com writes the Market Taker Edge options newsletter. Dan has more than 17 years’ experience in the options industry as a market maker, Options Institute instructor and author of “Trading Option Greeks.”