Traders were a little less panicked yesterday, which is not a huge surprise considering how close the S&P 500 was to its support level.
Thanks to a better than expected GDP report, which showed a 33% increase from the dip last quarter, the mood on Wall Street was much improved.
Although we would not recommend putting very much weight on the weekly unemployment claims number, it was better than expected as well.
We’re cautiously bullish, which has been the case for many months, and we’ve had to consider our trades very carefully. One reason we do keep selling options, even as the market becomes prone to bigger swings, is that the risk/reward picture supports it.
Let’s take a look at the CBOE S&P 500 Volatility Index (VIX) to get a better idea of what we mean.
The VIX is a measurement of the anticipated volatility being priced into S&P 500 options for the next 30 days, and it can be helpful to illustrate market sentiment.
When it goes up, traders think there is a greater chance of a large move in the next thirty days. In the chart below, for example, you can see that the VIX jumped in March. That’s because as more traders sold off because of the pandemic, investors anticipated more large moves in the future.
Daily Chart of CBOE S&P 500 Volatility Index (VIX) — Chart Source: TradingView
This week, we saw a huge spike in the VIX, meaning there is more volatility in the market.
That makes perfect sense, and we’ll talk about why… and we’ll also take the time to tell you why that’s good for options sellers.
Selling “Insurance” That Doesn’t Pay Off
Option contracts are like an insurance policy against swings in the market. If you think your stock might drop, you can take out a put option contract that will let you sell the stock for a particular price, limiting your losses.
We all pay for car insurance. And when we’re in an accident, it keeps us from having months of our lives ruined. Options serve the same purpose.
And just like insurance, they don’t always pay out, which is perfect for option sellers, like us.
The silver lining of all this volatility is increased option premiums.
If you thought you were more likely to get into an accident, you’d be more willing to pay for car insurance. Your insurance company would charge you more because it is taking on additional risk.
The market is the same way. Because there is a greater risk of a large move, option sellers can charge greater premium.
But we still have to identify the right sector for an options play. Fortunately, we think we’ve found it…
The Many Things Moving Retail
According to American Express (NYSE:AXP), retail spending improved last quarter, even as travel and entertainment spending decreased. CFO Jeffrey Campbell attributes the uptick in spending to online transaction growth, and that’s a trend we’ve highlighted in the past.
In September, we took a look at Target (NYSE:TGT). The company has had a tremendous year. It has proven that it is ready to compete with Amazon (NASDAQ:AMZN) for market share during the pandemic, and Wall Street has taken notice.
Traders launched the stock higher on Aug. 19 after the company smashed revenue estimates by $2.87 billion and non-GAAP earnings estimates by $1.74 per share — coming in at $22.98 billion and $3.38 per share, respectively — during its latest earnings announcement.
These incredible numbers were driven by a 195% year-over-year boost in digital sales and an amazing 24.3% boost in comparable in-store sales. It seems that consumers are not only shopping more at TGT but also buying more when they go.
Today, we like Nike (NASDAQ:NKE) for the same reasons. This isn’t new. People have been praising NKE for its focus on digital sales since 2019, but the pandemic has made digital sales critical. NKE has one of the best direct-to-consumer (DTC) strategies around.
NKE pulled back with the rest of the market this week, and as the stock bounces up from support, we like the idea of adding a little more exposure to retail as we head into the fourth quarter shopping season.
Daily Chart of Nike (NKE) — Chart Source: TradingView
From a technical perspective, we feel that $120 is a firm layer of support the stock is unlikely to close below, which does lower the risk of our chosen strategy: selling a put write.
There are still a lot of things that could cause the stock to move. But as explained, that works to our advantage as option sellers. We need traders to be convinced NKE could make a big move.
The catalysts we are focused on include the labor report next Friday — a better than expected result should boost NKE — and the leading retail sales data that will be streaming in with earnings over the next two weeks.
Disappointments could send the stock lower, but that’s where support comes in. If you set a strike price below support and an expiration later in November, you can capitalize on the volatility while limiting your risk.
Retail trades are always big this time of year, and investors are more inclined than ever to hedge their long stock positions. Why not capture some of that money for yourself with a put write?
On the date of publication, John Jagerson & Wade Hansen did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
John Jagerson & Wade Hansen are just two guys with a passion for helping investors gain confidence — and make bigger profits with options. In just 15 months, John & Wade achieved an amazing feat: 100 straight winners — making money on every single trade. If that sounds like a good strategy, go here to find out how they did it.