How Dark Pool strangles work … Understanding “the Greeks” in options … checking in on a live Dark Pool trade

 

Let’s say you want to make a trade on, say, media giant, Comcast.

The only problem is you don’t know which way Comcast’s stock is going to move.

So, to cover your bases, you take the money you had decided to sink into Comcast and break it into two halves.

You allocate the first half to a bullish position on Comcast, and the second half to a bearish position.

One day later, your combined, net trade is showing a profit of just under 5%.

This is not a hypothetical.

This just happened in a live Comcast trade from our most recent analyst, Stefanie Kammerman.

She initiated this two-direction trade (called a “strangle”) on Wednesday.

Yesterday — just one day later — the composite trade was up nearly 5%.

Now, this begs a question …

How?

How can two, opposite trades net-out to make an investor money?

Today, let’s shine a light on the answer.

In doing so, we’ll make you a more-informed investor. And that, in turn, can help make you a far wealthier investor.

Let’s jump in.

***The background behind a “strangle” trade

 

Let me make sure we’re all on the same page for any newer Digest readers.

The latest addition to our InvestorPlace stable of analysts is former-Wall-Street-pro, Stefanie Kammerman.

In her newsletter, Dark Pool Trader, Stefanie monitors the private stock exchanges where the Wall Street “big boys” place their trades.

When I write “big boys,” I’m referring to institutional traders that need to move massive chunks of stock — many times in the hundreds-of-thousands of shares.

When the big guys buy or sell in this quantity, it can easily push a stock’s price around by 5% – 10% in the span of a week.

Stefanie’s system catches these “prints” that show up in the Dark Pool exchanges (you and I can’t see them in our regular brokerage accounts).

Sometimes the likely direction the stock will move based on these prints is clear. In that case, Stefanie recommends a single-direction trade using either a call or a put (“calls” and “puts” are options — Stefanie explains how to use them in her service — they’re easy to learn).

For example, one of Stefanie’s first recommended trades for new subscribers after her Dark Pool Trader event a week-and-a-half ago was a single-direction, bullish bet on Yamana Gold (AUY).

Not even a full week later, Stefanie’s subscribers who followed her recommendations closed out the trade as a 100% winner.

Other times, the direction a Dark Pool trade might go isn’t as clear.

In these cases, Stefanie recommends both a bullish and bearish position, again, called a “strangle.”

The bullish part of the trade takes the form of a “call” option. The bearish part of the trade comes through a “put” option.

***As an illustration of how a strangle works, we can point toward the very first Dark Pool trade we profiled here in the Digest, which was on oil services giant, Schlumberger

 

By the end of the trading day of Stefanie’s alert, Schlumberger’s stock price was sliding (good for the put, bad for the call).

The next day, the stock fell further …

Just two days after the “buy” notice, Stefanie sent word to close half of her Schlumberger puts …for a ROI of 108%.

The following day, she sent instructions to sell the second half of the puts. This time, locking in 180%.

A simple, blended return of 144% on the bearish side of the trade …in just three days.

Now, to be clear, the bullish side of the trade — the calls — didn’t go anywhere. So, that invested capital went to $0.

But as we just noted, the blended return on the puts was 144%. So, even factoring in the calls, the total return on the entire strangle was still nearly 75%…in three days.

Okay, so that’s the background, but the question remains …

How does it really work?

And is this type of trade an anomaly, or is it something that Dark Pool traders can benefit from repeatedly?

***A deeper dive into how options work

 

The average investor has a less-than-complete idea of how options get their value.

As a “derivative” asset, an option “derives” its value from something else — in this case a stock. So, as a stock rises or falls, it affects the values of the options related to that stock.

Now, the investor who doesn’t fully understand options usually believes that an option’s value rises or falls in lock-step correlation with the price-action of the related stock.

But that’s not the case.

It turns out, the rising or falling of a stock is just one of many things impacting the value of a related option.

Now, a quick note …

What I’m about to tell you isn’t necessary if you want to be a Dark Pool trader. I’m writing simply to provide you a greater awareness of options, since they’re a powerful tool for investors when used properly.

So, don’t worry if the feels a bit fuzzy to you.

***An option’s price is influenced by a number of factors, among them are “the Greeks”

 

The Greeks are a set of risk measures named for the Greek letters that represents them. There are four main ones:

Theta, Vega, Delta, and Gamma.

I won’t get into each because it’s not necessary. But as a general illustration, let’s look at one — Vega.

“Vega” measures how much an option’s value changes based on changes in the volatility of the related stock.

Take Coca-Cola …

It’s a pretty steady stock. It doesn’t have crazy price-swings like, say, a tiny biotech that can soar or plummet 50% in a day for no good reason.

Let’s use the hypothetical chart below to approximate Coke’s relatively steady market-action over a couple weeks.

 

So, if Coca-Cola’s stock price suddenly began bouncing all over the place — up big one day, down big the next — the Vega value of Coke’s options would jump higher, increasing the value of those options.

And this would happen even if Coke’s stock ended up trading around the same level as where it began.

I’ve illustrated this hypothetical below …

 

If the above situation played out, the Vega of an option would gain value, even though the stock price itself ends up in pretty much the same place over this period (as you can see by the red line).

Stefanie’s Dark Pool system is based on catching the big moves of stocks. And while a “big move” would clearly impact the stock’s price (and therefore the value of related options), the exaggerated volatility itself would have a secondary impact on the options.

What this means is that options can gain lots of value, very quickly, under certain circumstances — well over 100%.

But on the flip side, when you buy an option, can you never lose more than 100%. And this is the basis of how a bullish and bearish bet on the same stock can become a winner.

You’ll never lose more than 100% on the “wrong” side of your strangle. But thanks to the Greeks, the winning side can often climb well over 100%.

And that marginal difference is where Dark Pool traders get their profits when trading a strangle.

***How the Comcast trade was up the day after its recommendation

 

Let’s return to the Comcast trade that opened this Digest so you can see how this works.

Stefanie recommended this trade on Wednesday.

The official buy-price of the call was $0.21 per contract. The official buy-price of the put was $0.18 per contract.

Looking at Stefanie’s portfolio a day later, we found that the call value had climbed $0.03, or 14.3%.

Meanwhile, the put value had dropped just $0.01, or 5.5%.

Netting these two positions out, the full-trade was up almost 5% in a day.

Now, as I write Friday morning, the combined trade has moved lower. This is normal, as option-values bounce around frequently, and we’re only two days after the launch of the trade.

But if this Comcast strangle ends up like so many of Stefanie’s other trades, we’ll see its value climb over the coming weeks.

Bottom line, if there’s a big-enough “splash” in the stock as Stefanie calls it (a big move), that — along with the other Greeks — will help drive the value of one side of a strangle above 100%. And that means the trade will become yet another another Dark Pool winner, even though one half of it moved in the wrong direction.

Pulling back, when you understand how options work, it opens up a new world of trading possibilities.

Do investors need to be careful when using them? Absolutely.

But can wise investors, using them appropriately, make big returns? Absolutely.

To learn more about how Stefanie uses them, click here. Have a good evening,

Jeff Remsburg