At the end of 2017, Cabot Dividend Investor’s chief analyst Chloe Lutts Jensen released her list of the Five Best Dividend Stocks for 2018. Her recommendations were American Express (AXP), BB&T Corp (BBT), CME Group (CME), Emerson Electric (EMR) and Microsoft (MSFT). These five stocks pay dividend yields of 1.39% to 2.5%. But by using options, you can significantly boost the yields on these stocks. I detail below how you can increase the yield on two of her stocks to 4.82% and 5.2%!
But first, let’s review what Chloe said about what to look for in dividend stocks.
“Don’t just look for the usual indicators of a good dividend stock, like a long dividend history: focus on factors that will attract more investors to the stock short-term. Those can include big dividend increases, earnings beats and of course a stock chart that’s moving up.
“Companies whose earnings growth is expected to accelerate next year—meaning analysts expect earnings to grow even faster in 2018 than they did in 2017—are likely to attract more investors as 2018 passes, pushing their stock charts up. They’re also likely to deliver the big dividend increases that draw more investors into a stock.”
A covered call is a strategy in which the trader holds a long stock position and sells a call option on the same stock in an attempt to generate income. For every 100 shares of stock you own, you can sell one call. For example, if you own 500 shares of stock , you can sell five calls.
A covered call is a very conservative strategy that requires no margin. It’s a great way to create yield and lower your cost basis on your stock position. (The downside is that you give up the potential for explosive upside gains.)
In my opinion, covered calls (also called buy-writes) should be a core strategy for all investors. At Cabot Options Trader and Cabot Options Trader Pro, we always hold a couple of covered call positions to give us slow and steady gains every month.
So how might we combine Chloe’s recommendations of American Express (AXP) and Microsoft (MSFT) as the best dividend stocks for 2018 with a covered call strategy?
Using Covered Calls on the Best Dividend Stocks for 2018
Here are Chloe’s comments on American Express (AXP):
“Modest 2017 revenue growth of about 4% is expected to accelerate to 6% next year. And earnings growth is accelerating as well: analysts expect 4% EPS growth this year to improve to 11% growth next year. The stock is reflecting that improvement: AXP has been in an uptrend since October 2016, and has so far advanced about 50%, bringing the stock to all-time highs. More of the same is likely to attract even more investors to AXP in 2018.”
So if we bought 100 shares of AXP today at 100, we could sell one AXP April 100 Call at $4.50.
And because each call represents 100 shares of stock, the $4.50 call is actually worth $450, which we collect.
Here’s the breakdown on the upside and downside to this position:
The most we can make on this trade is $482 per covered call if the stock closes at 100 or above on April expiration (April 20, 2018). I get to $482 by adding the dividend of $32 plus the $450 from the call sold. This would give us a yield of 4.82% in four months’ time.
However, if AXP were to trade above 100 on April expiration, we would be taken out of our stock and call position by the trader who bought our call. (This is the negative part of covered calls … your upside is limited.)
The combination of the dividend collected and the call we sold places our breakeven at an AXP share price of 95.18.
Next let’s take a look at Microsoft (MSFT). Here are Chloe’s comments:
“As one of the oldest tech giants, Microsoft has a much stronger dividend history than many of its peers: the company has paid dividends since 2003 and increased its dividend in each of the past 13 years. Today, Microsoft’s dividend is nearly double what it was five years ago.
“And the company is still growing: analysts expect 9% sales growth this year and next. Earnings are expected to rise 3% this year, and 12% next year.”
If we bought 100 shares of MSFT today at 90, we could sell one MSFT January 100 Call (expiring 2019) for $4.
Here’s the breakdown of the upside and downside to this position:
The most we can make on the trade is $1,568 per covered call if the stock closes at 100 or above on January expiration (January 19, 2019). This would be a yield of 17.42% in 11 months’ time.
However, if MSFT were to trade above 100 on January expiration, we would be taken out of our stock and call position by the trader who bought our call.
If the stock is unchanged (still 90) on January expiration, the combination of the dividend and the sold call will have created a yield of 6.31% in 11 months’ time.
The combination of the dividend collected over the next 11 months and the calls we sold puts our breakeven at a MSFT share price of 84.32.
As you can see from the examples above, covered calls are a great way to create yield and reduce your breakeven on a position—and not just on Chloe’s best dividend stocks for 2018!
Here are some recent covered call successes subscribers to Cabot Options Trader enjoyed:
FCX covered call yield of 8.29%
FCAU covered call yield of 3.66%
BAC covered call yield of 4.55%
PHM covered call yield of 3.46%
If you have never traded covered calls before, I recommend that you first choose a stock in which you own at least 100 shares and sell one call against it. So even if you own 1,000 shares of Facebook (FB), I recommend that you sell just one call to see how the strategy works.
If you have any questions on how to execute this strategy, you can join Cabot Options Trader here to receive further guidance on your trading.
Once you become familiar with the strategy, you can execute more covered calls. By adding this strategy to your investing arsenal, you can create more yield for your portfolio every month.
Stocks like Square (SQ) and Micron (MU) have led the market higher for most of 2017. Buy in the last two weeks, these stocks, and many leading growth stocks, have begun to weaken. Want to know how to protect your stock gains while continuing to hold those two stocks for upside? Buy protective puts.
First, let’s look at what Mike wrote about Square:
Square (SQ), which also had a big run recently, rallying a bit more than 30% during the past two weeks before Monday’s plunge. However, prior to this rally, the stock had enjoyed a monster move, rallying from a breakout point near 16 in February (and even more from its mid-2016 low near 9!). Combined with the recent downdraft, the action raises the odds of an intermediate-term top and is probably a good reason to at least sell some of your shares.
However, if you didn’t want to sell your shares because of tax reasons, belief in the stock in the long term or any other reason, you could use a protective put options trading strategy.
How to Protect Your Stock Gains with Protective Puts
A protective put is used when a trader is bullish on a stock he already owns, but wary of the stock’s short-term future. It is used as a means to protect unrealized gains, while giving the trader continued upside potential.
Theoretically, if you own 100 shares of Square (SQ), and the stock is trading at 38, this is how I would implement the strategy.
First, I would continue to hold my 100 shares.
Second, I would Buy to Open one SQ March 36 Put for $3
The total cash outlay for the put is actually $300 because each put represents 100 shares. That $300 is the insurance policy you took out on your stock position, and will protect your 100 shares if SQ were to take a much bigger fall. Here’s a graph of the stock position combined with the put purchased:
In essence, you have bought an insurance policy that will protect you for four months from a big fall. If SQ falls, your losses are stopped at 36, which is the strike price of the put that you bought. At 36 or below, you have the right, but not obligation, to exercise your put, which would take you out of your SQ stock position. You would likely exercise this right to sell your stock at 36 if SQ had fallen precipitously lower.
However, to the upside, your potential gains are unlimited!
Next let’s apply this strategy to Micron (MU), which had been on a monster run, but has recently been under pressure.
Again, assuming you own 100 shares of MU, which is trading at 42, and want to execute a protective put strategy, you could Buy to Open one MU March 42 Put for $4.
When you buy this put for $4, your total cash outlay is actually $400 because each put represents 100 shares. That $400 is the insurance you took out on your stock position and will protect your 100 shares if MU were to take a much bigger fall. Here is the graph of the stock position, combined with the put purchased:
Similar to the SQ example, you have bought an insurance policy that will protect you for several months. If MU falls, your losses are stopped at 42, which is the strike price of the put that you bought. At 42 or below, you have the right, but not obligation, to exercise your put, which would take you out of your SQ stock position. You would likely exercise your right to sell your stock at 42 if it had fallen precipitously lower.
However, to the upside, your gains are again unlimited!
What makes these such compelling trades is that they protect the stock holding for several months against general market drops, North Korea headlines, Washington D.C. risk, etc. And because the puts don’t expire for several months, they also protect your holding against Square’s and Micron’s next earnings announcements.
While I don’t love paying for insurance/puts, given the recent dramatic drops in Square and Micron, this strategy is a great way to protect my stock holding while continuing to give me upside potential.
If You Bought My Call Option Recommendation in October, You’ve Gained 171%!
Call option buyers perfectly timed the bottom in Shopify (SHOP) stock following the stock’s dramatic decline in mid-October. And the call buy I recommended in my Wall Street’s Best Daily on October 11 is now at a profit of 171%!
If you don’t remember the story, short selling firm Citron accused Shopify of being a “get-rich-quick” scheme and urged the Federal Trade Commission to investigate the company. Citron put a price target of 60 on SHOP, almost 50% lower than the stock’s price when the research note was released.
A couple of days later, I wrote a Wall Street’s Best Daily with my thoughts on Shopify and a trade idea. Here’s what I wrote.
“So with Shopify stock falling and uncertainty around the company picking up, how could I trade SHOP using options?
“Buying call options is the best risk/reward setup. And I may try to buy SHOP calls in the coming days if my Unusual Options Scanner tool tells me that big traders are stepping in and buying Shopify stock options.
“And if SHOP Option Order Flow turns bullish, with Shopify stock trading today at 92, I might look to buy the January 100 Calls for $7.
“What makes buying these calls so attractive is that my downside is limited by my premium outlay on the trade: $700. This is a significant discount to paying $9,200 for 100 shares of the stock. And if SHOP stabilizes and runs back to its old highs and beyond, my upside is unlimited!
However, if Citron is right, and SHOP is a short and the stock drops, the most I can lose on the trade is $700.”
Buyer of 3,500 Shopify (SHOP) November 100/120 Bull Call Spreads for $3.55 – Stock at 92
Buyer of 3,000 Shopify (SHOP) November 100 Calls for $4.85 – Stock at 92.5
That was exactly the type of bullish option activity I was looking for! A trader was putting on a high conviction trade, with nearly $2.7 million at risk. And as the graph below shows, October 11 was the bottom in SHOP stock:
So if I had bought the January 100 Calls for $7 as I had recommended, and they are trading at $19 today, how might I manage that position?
First off, when I have a big winning options position, I always sell half and let the rest run for bigger profits. Selling half allows me to shoot for a home run with the rest of the position because I have partial profits in the bank.
And once I have sold half, I set a mental stop on the remaining half, which I continue to raise as the stock goes higher.
In this case, if my SHOP option that I bought for $7 was now worth $10, I would set a mental stop at $9. If the option fell to $9, I would sell my calls for a modest profit.
However, if the stock continued to rise, and my mental stop was NOT hit, I would raise my stop along the way. If the option went to $14, I would raise my stop to $13. I would let it run higher and higher, and raise my stop as it did.
17+ Year Pro Options Trading Veteran and Former CBOE Market Maker Shares His Knowledge
From pit experience as the designated primary market maker to setting up a proprietary trading desk, this professional options trader shares his years of Wall Street and market experience.
Jacob Mintz has been a professional options trader for 17 years. He is chief analyst of Cabot Options Trader and founder of OptionsAce.com. Jacob began his trading career as a market maker on the floor of the CBOE, where he traded for nearly 10 years. In 2008, Jacob was tasked with leading the merger of three trading crowds on the CBOE. As the Designated Primary Market Maker, he provided the largest and tightest option spreads for any option order that came into his pit. While in this role, Jacob helped develop a sector trading system and managed the group’s risk. In late 2009 he set up a proprietary trading desk. In this role, he was in charge of strategy, risk mgmt and trading. Jacob has a passion for sharing his knowledge and experience from “Wall Street” and he travels the country educating beginner and intermediate-level options traders in a one-on-one mentoring environment. Below is a re-cap of a live Q&A we had with the entire StockTwits community. For the full transcript please GO HERE.
I’ve had a great year. Though I suppose a bull market makes everyone look smart. My last several months’ worth of trades are
What is a good starting point to learn or even practice options trading? —choicesblk
Learning about options is similar to learning a foreign language for many people. So what I recommend is that you start slowly. First, really learn what a Call is. Next make a fake trade. Say to yourself, “I think stock XYZ is going higher, so I’m going to buy the XYZ January Call” And then track the trades success or failure. Then learn what a put is. Make a fake/paper trade and track it. Next learn what a covered call/buy-write is. Then when you have those three strategies down, then you should actually buy a call or a put. Put some money on the line. But only buy ONE contract. Learning how to execute a trade is also new to many people. So if you make a mistake, or lose on the trade, it won’t hurt too badly. What I do NOT recommend is spending thousands of dollars on a video course teaching options. The amount of people I know who have spent thousands of dollars on video courses who are unhappy with the results is overwhelming. I teach options students in a one on one environment. That way I can see if you are really understanding a concept.
I’ll go right for the big one. How do you manage your positions? How do you use options to reduce your risk once in a trade? — michaelbozzello
Every trader is different, and every trader has their own strengths and weaknesses. The mistake I made too often in the early part of my career is taking off a winning trade too soon. We all love to lock in profits, but often times that is the worst trade. So with that in mind, this is how I trade a winning position. Once I’m up 20–30% on an options trade I sell half. Those profits will let me go for the home run on the balance. Then I set a mental stop on the balance, and raise that mental stop along the way higher. For example, last year I hit a home run in $NVDA. Originally I bought the June 33 Call for $2.18. A couple weeks later I sold HALF of these calls for $2.96, or a profit of 35%. Then I went for the home run! As the stock ran higher, I kept raising my mental stop. This allowed me let the trade run, while protecting myself should NVDA fall. So when the option was worth $7, I had a stop at $6. When the stock ran higher and the call was worth $9, I moved my stop to $7.5. Finally my mental stop was hit, and I sold for $13.25, or a profit of 507%
Should we assume that robots extend to all portions of options trading? — RonTurkey
Yes unfortunately there aren’t many humans/floor traders left. The computers are making 99% of the options markets that you
see. They are just too fast to compete with. That said, I’m still buying and selling. And so are many of you.
And at the end of the day, it’s not such a bad thing that the computers have taken over. Why? Because they can make $BAC
options markets a penny wide. I couldn’t do that on the floor. So you and I pay less when we are buying and selling options.
That said, man I wish I was still on the trading floor! But the world has changed, so we have to change with it.
Which valuation model do you prefer for the current market environment? BSM, Binomial or a custom one? — MaxPowerDoe
That is above my pay grade. I’m just a dumb options trader ☺
If you were to teach every person one thing from your experiences on Wall Street, what would that be? —Jayhead13
Wow that is a tough question! I guess never stop reading, and learning about the market! I studied under two trading floor legends at the CBOE, and they taught me a ton. But even today, I talk to my fellow analysts at Cabotwealth.com and continue to be amazed at new ideas and strategies.
What’s the stupidest options trade you gladly filled (e.g. someone buying a bunch of extremely OTM calls/puts)? —CaptainFalcon
Usually someone buying calls extremely far out-of- the-money was a winning trade for me, and a losing trade for them. That said, as we all know, unfortunately insider trading does happen. So when a trader is buying calls with a couple days till their expiration, far from the current stock price, alarm bells go off in my head. Like “Why would someone be throwing away hundreds of thousands of dollars buying these calls?!!” And next thing you know, the stock is taken over.
On monthlys, how far out is a good rule of thumb like 1–3 month? Given time decay and expense with longer exp dates. — absolute0
Everyone has a different take on this type of question. Personally, I’m allergic to time decay. I hate buying calls/puts and watch them lose value. So I tend to buy calls with 3 plus months until expiration. While these calls cost more, they don’t decay at nearly the rate of options expiring in a month. The cost vs. decay debate is not easy.
Are most traders selling puts & calls rather buying? Why is collecting premium better than speculative buying? — absolute0
I guess I don’t know what “most” traders are doing these days. And I don’t think selling vs. buying is “better” or vice versa. My style is that I don’t have a style. Why would I want to only trade one way? If it’s a bull market, then by all means buy Calls. If it’s a choppy/sideways market, then sell volatility via Buy-writes, Put-writes and Iron Condors. If you pigeonhole yourself to one
style, you will miss out on plenty of money making trades.
How to get started in the industry? What type of education would you need and how to go about landing an internship? — FrankieJ
You don’t have to be a rocket scientist to be a successful trader! There were plenty of traders who flamed out on the CBOE who graduated from Harvard/MIT. And there were other guys who had amazing careers, who never went to college. And then I suppose it’s all about networking. I don’t know the actual numbers, but the amount of people who get jobs via
personal connections has to grossly overwhelm the amount of people who get jobs via sending blind resumes. I got my interview with my future boss because my uncle knew the guy from his neighborhood. Then it was my job to impress him via math questions and answers etc.
If you were investing in $SHOP for long term. What option strategy would you use? Plain LEAPS or Bull Call Spread? — peterjakonovisky
I guess the answer to that is how high do you/I think SHOP can go. If I think the upside is limited to 120 for example, then I would buy the 100/120 Bull Call Spread. If I believe SHOP is the next great stock, and could go to 200 and beyond, then buy straight calls, and go for the big home run.
How do you set your profit targets? If it hits your target do you sell 100% or do you try and scale out? — brent3
I never set price targets. I’m a home run hitter. And if I set a price target, I’m limiting my upside. That said, as I mentioned above, I sell HALF at a profit of 20–30% and then raise mental stops as the stock and my option go higher. That protects me from a big fall, and protects me from making the mistake of selling a big winner too early.
How do you establish your stop loss? Is it a percentage move in the underlying stock or certain dollar amount? — brent3
First off, I NEVER double down on a losing trade. As the famous Paul Tudor Jones sticky note above his computer in his office said “Losers average Losers”.
That said, sometimes I get stopped on trades. Other times, I give trades time to work. For example in the last couple months I bought $MU calls after tons of unusual call buying. And then, a couple days later, $MU and all of the semiconductors fell hard. The trade was a loser! Yet the call buying never stopped, and even became more frenzied. So I held the position, and the stock
roared back to life. I closed that trade for a profit of over 225% this week!
I have a couple sell signals. The first is watching option order flow. If there is steady call buying in the market leaders such as $FB $GS $BAC $BABA then I read this as the big traders have faith in the market. However, when that call buying flips to put buying in those stocks and the indexes, I become wary. And when its 2–4 days of that activity, I unload some of my positions. Also, while I don’t like trading the $VIX, I absolutely keep an eye on it. My very simple rule is that if the $VIX is at 9–13, the hedge funds and institutions are ok with the market. 14–17 in the VIX I’m paying attention. 18 and above, it’s time to sell first, and ask questions later. Remember, just because you sell, doesn’t mean you can’t get right back in.
Which kinds of unusual option activity are the most useful to trade off of, and how do you trade it? — MaximaTrader
The size of the trade vs. typical trade volume. By this I mean, someone buying 5,000 calls in a liquid stock like BAC means very little. However, if there is a buy in a random stock, that hardly trades options, my alarm bells go off.
And when there is repeated buys, day after day, it means the trader has high conviction in the trade. And when the trader pays higher and higher prices, it means they want in badly. And last, it’s a feel. By this I mean, when a trader is making a super suspicious trade, like buying calls far out-of-the-money with three days till expiration, I wonder why the heck would they be doing this? And that is when I want to take a shot that this trader may know news is coming.
What do you believe helped you the most throughout your career? Whether it be a strategy or advice someone told you. — ItsCharlemagne
I guess at the end of the day I’ve tried to make trading as simple as possible. While you or I can create some crazy algorithm, I find it easier to use my own brain/reasoning. I evaluate trades in terms of odds. If I like $FB, and the stock is trading at 175, I ask myself how high do I think it can go. If the answer is 185, then I buy the 175 or 180 call depending on the price. However, if
those calls cost $10, and I feel they are grossly too expensive, and hurt the odds of success, then I move on. To me, trading is all about odds. I execute only the trades I like best. And some will work, and some won’t. But if I’m selective, and put on trades with a great chance of succeeding, over time I know I will be profitable.
What do you think about $TRXC both short term and long term? — wgrif
I’m not a chartist. @MikeCintolo is the chartist I turn to, especially when it comes to growth stocks.
What % of portfolio should be allocated to options for adequate diversification ? e.g: Let’s say $100k in equity —bismilmastrading
Unfortunately, I can’t answer that. All traders/investors have different goals/timelines.
When you have a winning options trade, do you sell the position and roll out to a more distant strike? — Bubble_Detective
As I mentioned previously, I tend to hold my winning calls/puts as long as possible, using a mental stop, that I raise higher and higher.
Can a decent trader win in the long run by being long spreads, or do you need to sell premium to have a prayer? — JackBeTrader
Absolutely you can win be long options. It only takes a couple home runs being long options to make a career. That said, I think being able to trade both long and short options has the best chance of success.
How much impact can MM’s and OI have on a 5B-20B mkt cap names like say an $AMD or a $SNAP? — JackBeTrader
The power of those “evil” market makers is grossly exaggerated. Trust me, back in the day my firepower on the trading floor wasn’t going to move a stock for an extended period of time.
I write opts at low volume and have tried to learn some MM’s style. Some of them won’t budge. What’s my best tactic? — bearcharts
First off realize that today those market makers are computers. And they don’t care about you or me. They are there to make money. If you are having trouble getting filled, offer small amounts at a time. Size orders can scare off a fill.
Do MM’s ever stay stubborn or cagey as a revenge move when they think they spot a particular retail customer? — bearcharts
Those days are long gone. Again, the MM’s are now computers. And they don’t hold grudges like I used to. ☺
I always battle to select the right Strike Price and period to expiration for Options. Guidance on this somewhere? — Leisure_Suit_Larry
Make this as easy as possible. Ask yourself, “at what price am I willing to sell the stock?” Once you have that number in mind, sell that strike call. Keep it simple. Conversely, if you want to sell a put, ask yourself, at what price am I willing to buy the stock. Then sell that strike put.
What is your analytical framework for managing and hedging option strategy risk? — Milton_FMR
For most traders I would say this … Determine where your exposure is. Tech or Financials or Pharmaceuticals? Then determine at what point you want to get out should the stock/sector fall, and on what time frame. Then buy as many puts that allow you to sleep at night.
How can options be used as a tool for more effective and profitable trading? Can beginners use these tools? — McCarthyWill
Buy-Writes should be in every investors arsenal in my opinion to create yield. Calls should be used to take speculative shots, and puts should are a great tool for hedging/shorting. Anyone can use these strategies!
Do you feel letting in the money calls expire and taking delivery of the shares a viable strategy? — 1dayasalion
Absolutely, if you want to own the stock, take delivery. At Cabot Options Trader we sell out our calls/puts before expiration.
Where should I apply to as an undergraduate for a trading career? Prop firms? Most firms need capital to join.— jl_719
Unfortunately trading firms have changed a great deal over the years, and most require capital and charge ridiculous commissions and fees. Be careful on those fees if you find a prop firm.
If you have high conviction in a trade absolutely buy ITM calls/puts. If more speculative, go OTM.
If an MM has a large amt of calls bought from them, does the MM immediately purchase equivalent shares to stay flat? — ProfitDesigner
Depends on the firms “style”. Some are trying to stay flat via buying stock against a sale. Others will buy calls in another stock in the sector. Or others will balance vs. exposure to overall market.
What was your most successful stock you invested in, and why did you choose to invest in it? — otcwolfdz13
Trading Google made my career. Mostly I churned out profits as a market maker every day. But the greatest trade of my career was made trading the stock, and it was PURE luck. But that is a long story for another day.
I’ve been paying car ins. PREMIUMs 35 years w/o a claim, is that Theta, time decay or rube? — kevinbantzcom
Just like puts held against a portfolio, or your home insurance, that is the price of sleeping well at night.
Probably already asked but do you have a favorite strategy? — StocksAndStones
I don’t limit myself to a favorite strategy. Every market/stock situation requires a different tactic/trade.
Any memorable large options trades you can recall in your career? How did they work out for the parties involved? — Lonesome
Plenty I can think of. Always seem to be trader buying calls before takeovers. White Wave, Nymex, XMSR etc.
In terms of trade strategy & risk mgmt, what are the differences between a prop trading desk and market maker? — Lonesome
Market Makers are there to provide liquidity and make money on the spread. Prop desks are there to make money
Short selling research firm Citron took aim at Shopify (SHOP) last week, sending the stock lower by 16%. Citron called Shopify a “get rich-quick” scheme, urged the Federal Trade Commission to investigate the company, and compared SHOP to hotly debated stock Herbalife (HLF). The firm put a price target of 60 on Shopify stock, almost 50% lower than it was trading on the day the research note was released. It was NOT a great week for SHOP shareholders.
So with Shopify stock falling and uncertainty around the company picking up, how could I trade SHOP using options?
Buying call options is the best risk/reward setup.
That said, my experience tells me that I should would wait at least three days before buying calls.
I began my career on the floor of the Chicago Board of Options Exchange in 1999 straight out of college. For a year, I stood next to two options trading legends, soaking up all of their wisdom as their clerk. That year, the market ripped higher as virtually every dot-com stock exploded higher day after day. I learned a great deal during that bull run.
Here is a picture of a younger me (with more hair) in my trading pit on the CBOE.
Soon after I became a trader myself, the Nasdaq fell apart. The dot-com bubble burst, and valuations were reset for virtually the entire market. I learned even more during those bearish years than during the bull market years!
The old trading rule that was hammered into my brain by my two trading legend mentors was this:
If a stock takes a big fall, whether it’s on earnings or some other news event, you MUST wait at least three trading days before even thinking about putting on a bullish position.
The rationale behind The Three-Day Rule is that if a large hedge fund or institution owns millions of shares of a stock, it won’t be able to sell out of its entire position in a day or two without causing the stock to fall.
My LinkedIn (LNKD) Example
Instead, the institution will parcel out its sales over a couple of days, so they don’t depress the stock and can sell at better prices. For example, let’s take a look at LinkedIn (LNKD), which fell from 192 to 108 in one day last February 5 on a disappointing earnings release. That was a staggering fall! The next day, the downgrades came pouring in from the brokerage houses (thanks for the downgrades after the fall!).
Based on the three-day trading rule, I wouldn’t have considered adding a bullish position on Friday, February 5, Monday, February 8 or Tuesday, February 9. But on Wednesday, February 10, according to the rule, I could begin to think about adding a bullish position.
Here were LNKD’s closing prices on the day of its earnings report and the following days:
As you can see, there remained selling pressure on LNKD in the three days after the big drop. Then, slowly but surely, the stock stabilized, and buyers began to take over.
I did not buy the dip in LNKD after the three days that the rule mandated because other stocks offered much better opportunities than LNKD. But I may try to buy SHOP Calls in the coming days if my Unusual Options Screening tool tells me that big traders are stepping in and buying Shopify stock Options.
And if SHOP Option Order Flow turns bullish, with Shopify stock trading today at 92, I might look to buy the January 100 Calls for $7.
What makes buying these calls so attractive is that my downside is limited by my premium outlay on the trade: $700. This is a significant discount to paying $9,200 for 100 shares of the stock. And if SHOP stabilizes, and runs back to its old highs and beyond, my upside is unlimited!
However, if Citron is right, and SHOP is a short and the stock drops, the most I can lose on the trade is $700.
As earnings season begins this week with reports from JPMorgan (JPM), Bank of America (BAC) and Wells Fargo (WFC), there will inevitably be some big drops in stocks you have interest in buying. However, before buying the dip that first day, remember what all experienced floor traders refer to as The Three-Day Rule.
As a trader of options on the Chicago Board of Options Exchange (CBOE) for over 10 years, I witnessed and heard many unbelievable trading stories. There were stories of traders risking too much and losing everything, and traders retiring by the age of 25 having made their fortune through skill or luck. But the greatest options trade I ever saw happened during the crash of 1987.
Legend has it that one trader thought he had bought one put on the S&P 500 (the right to short the S&P 500), only to find out many hours later he had bought 1,000. This lucky mistake netted him well over $10 million!
Another great story came from my old trading company. My former boss, a trading veteran of nearly 30 years and a millionaire many times over, was as cheap as anyone I’d ever met—in fact, he had never given a raise to a clerk or intern as long the company had been in existence.
One day, my boss and another trader got into a fistfight in the middle of the trading crowd. The fight deteriorated to the point that these two 50-year-old men were rolling on the ground wrestling. The story goes that my boss was in trouble as the other man had pinned him down and was repeatedly punching him in the face. Out of nowhere, my boss’ clerk, a woman no larger than 5’2” and 100 lbs. and whose voice never rose higher than a whisper, picked up a computer monitor and bashed it over the head of my bosses’ opponent.
As soon as the trading day ended, my boss walked across the street and withdrew $10,000 in cash and handed out his first ever bonus.
Clearly the trading floor is not for the faint of heart. However, for those that excel in the fast-paced world of trading, there’s no better place in the world than the CBOE.
The Greatest Options Trade I Ever Saw
Not many people outside of my old company know about this trade—it’s the greatest options trade I ever witnessed.
Some traders don’t stop talking about their brilliance and all the money they make through their great trading skills. Others like Pete, a trader who worked at my company, make their money quietly. That’s why so few know about this trade.
Pete traded in the Enron trading pit. For years, Pete made good money simply trading Enron in a conservative manner. However, once the cracks started forming in the Enron story, Pete used the leverage of options to build a massive bearish position.
In case you don’t remember, Enron was trading as high as 90 a share in August of 2000, and by December of 2001, the company would be near bankruptcy.
Pete didn’t make his fortune by shorting Enron at 90. In fact, he slowly made money trading it conservatively until the stock neared 35 in September 2001. At that point, the “sharks were circling” as big trading firms such as Goldman Sachs and Morgan Stanley were in Pete’s trading crowd buying as many puts as they could. With the stock trading at 35, these “smart money” traders were buying puts that would enable them to short the stock at 25 and 20. The other members of Pete’s trading crowd couldn’t believe the lunacy of buying these puts, so they aggressively sold puts to Goldman and Morgan Stanley.
Pete, on the other hand, quietly bought the same puts as Goldman and MS suspecting that the “smart money” might have more information than the rest of us. The stock collapsed in the proceeding weeks, trading at around 10 by early November 2011.
Most traders at this point would have locked in their profits, and maybe even taken a bullish position thinking that the company couldn’t possibly go out of business. In fact, our boss begged Pete to lock in his big score and get long. But Pete kept his short position, and continued to aggressively buy 10 and 5 strike puts.
Soon enough, the stock traded at under a dollar a share and Pete had made the greatest options trade I’d ever seen.
Pete wasn’t the smartest guy on the trading floor. He wasn’t even the smartest guy in my small trading company. But he’s one of the best traders I’ve ever seen at riding his winners.
Trading stocks and options is a great psychological battle with ourselves. Far too often, we sell winners too soon and let losers run too far. Just think about how great it feels to lock in a profit and get that instant gratification—yet these are the trades we should be letting run as far as possible.
Even with all of my trading experience, I still fight against myself. Earlier this year, my Cabot Options Trader subscribers and I had a big winning trade in Fiat Chrysler (FCAU) calls. We’ve seen our position increase to a 320% gain! The “smart money” kept putting on bullish options positions … and yet, I wanted to sell it when the market was going down for a day—the exact opposite of how I should have been thinking!
I’ve been winning this battle with myself more and more these days and I was able to hold this position for a triple-digit gain.
So next time you’re thinking about selling out a profitable position, ask yourself this: Are you selling it because you want the instant gratification of locking in a profit? If so, step back and rethink your trading plan … and maybe even think back to the story about Pete, and the greatest trade I ever saw.
As I shared after-hours cocktails with Cabot Wealth Summit attendees two weeks ago, a large table of us shared our big-picture stock ideas. On the subject of Tesla stock, my thesis, after a couple bourbons, was that because of the innovations in self-driving cars made by Tesla (TSLA) and Uber, my young kids may never get a driver’s license.
Countless neighborhood friends of mine, who have older kids who are of age to get their licenses, have told me that their kids have no interest. “Why would I want a car? I can just Uber” is what one neighbor’s son told his dad. And the research trends back up this lack of interest.
As noted in Money Magazine and Business Insider, Researchers Michael Sivak and Brandon Schoettle from the Transportation Research Institute at the University of Michigan compared the percentage of people of different age groups with drivers’ licenses in the United States in 1983, 2008, 2011 and 2014. The study found that in every year examined, there has been a decrease in the percentage of 16- to 44-year-olds with drivers’ licenses in the U.S.
From 1983 to 2014, there’s been a drop of 47 percentage points in 16-year-olds with drivers’ licenses. For people ages 20 to 24, there’s been a 16 percentage point decrease over the same time span.
And much of this data was compiled before Uber and Tesla began to really shake up the automotive world!
In 2015, these same researchers noted, “In the most extreme scenario, self-driving vehicles could cut average ownership rates of vehicles by 43 percent—from an average of 2.1 vehicles to 1.2 vehicles per household”.
And as we know, the range of opinions on Tesla and Uber is wide ranging. For example, earlier this year, China’s Tencent Holdings(TCEHY) bought a 5% stake in TSLA.
“Tesla is a global pioneer at the forefront of new technologies,” a Tencent spokesperson said. “Tencent’s success is partly due to our record of backing entrepreneurs with capital; Elon Musk is the archetype for entrepreneurship, combining vision, ambition, and execution.”
That said, there are no shortage of critics of the company, including Bob Lutz, an auto industry legend who held top positions at Ford(F), Chrysler, General Motors(GM) and BMW throughout his career. In a Los Angeles Times article Lutz had plenty to say about TSLA. Here are some excerpts:
What’s your take on Elon Musk and Tesla?
“I don’t know why it is that otherwise intelligent people can’t see what’s going on there. They lose money on every car, they have a constant cash drain, and yet everybody talks as if this is the most miraculous automobile company of all time.”
What do you think will happen with Tesla down the line? Bought by a traditional auto company?
“Maybe, but who needs it? [Musk] has no technology that’s not available to anybody else. It’s lithium-ion cobalt batteries. Every carmaker on the planet has electric vehicles in the works with a 200-300-mile range.
“Raising capital is not going to help, because fundamentally the business equation on electric cars is wrong. They cost more to build than what the public is willing to pay. That’s the bottom line.”
What about the design?
“The one advantage [Musk] has is that the Model S is a gorgeous car. It’s one of the best-looking full-size sedans ever. The Model X? It looks like a loaf of bread. There’s no arguing the Model 3 is nice-looking but it doesn’t break any new ground aesthetically.
“Don’t get me wrong, what Musk has achieved, whether it is profitable or not, is incredible. He’s created an automobile company based solely on electric vehicles, and they have pretty good, not yet completely reliable, autonomous capability.”
What Wall Street Thinks of Tesla Stock
Wall Street is also divided on Tesla stock, as traders position for the stock to crash, or explode to new highs.
So with TSLA trading at 345, how might I bet on, or against, Tesla stock trading options?
If I believed in Elon Musk, and the future of Telsa, I might execute the following trade:
Buy to Open the TSLA December 355 Calls for $22.
The most you can lose on this trade is $2,200 per call purchased, if Tesla stock were to close below 355 on December 15, 2017.
However, this trade has unlimited upside potential, just like a stock purchase, but at a fraction of the cost ($2,200 vs. $34,500)
If I wanted to bet against TSLA stock, I might execute the following trade:
Buy to Open the TSLA December 330 Puts for $20.
The most you can lose on this trade is $2,000 per put purchased, if TSLA were to close above 330 on December 15, 2017.
The advantage to buying puts is that most brokerage companies don’t allow average investors to short stocks. However, they do all allow you to buy puts, which is a bearish position, because your potential loss is limited to the price you paid for the put ($2,000).
From iron condors to bull put spreads, Jacob Mintz, editor of Cabot Options Trader, highlights a variety of options strategies, and discusses some trading positions on his buy list.
Steve Halpern: We’re here today with Jacob Mintz, editor of Cabot Options Trader. How are you doing, Jacob?
Jacob Mintz: I’m doing well. Thank you, very much.
Steve Halpern: How do you find your trading ideas for your Options newsletter?
Jacob Mintz: Well, when I’m looking for trading opportunities, I’m all about looking for probabilities and risk versus reward. For example, I say to myself, what is the probability of this stock moving 3% or 5% in a predetermined amount of time? Then I judge my risk/reward in buying or selling this option to determine if I like a trade.
Another way that I find my trades is through a strategy that I have found tremendous success with, which I call, order flow reading. This is, basically, following the largest and smartest traders in the world into the same trades that they’re putting on.
To find these trades, I have a scan that I’ve set up to alert me when an option is trading way outside its normal daily volume. For example, if a stock, such as stock symbol ABC, normally trades only a 1000 calls a day, and I notice that someone has bought 5000 or 10,000 calls, then I’m alerted to this.
Then I can judge for myself if I like the trade.
I know it’s hard to believe, but sometimes hedge funds, or other larger traders, get insider information, and they trade on this information. When they do this, it’s illegal; however, if I follow them and do a trade, and I have no insider information, there is nothing wrong with this.
Steve Halpern: You’re actually making the bet based on the increase in volume in the trade without having any specific information as to why the person buying that excess volume is doing so.
Jacob Mintz: That’s correct. These hedge funds-if they’re betting $5 million, $10 million, and $20 million on a call, for instance, they’re not doing it to lose money. They probably have a good feeling that the stock is going to go this way, be it their opinion on the market, or if they have insider information.
Steve Halpern: Do you typically buy options or sell them?
Jacob Mintz: Most traders identify themselves as either buyers of options or sellers of options. I think these traders are making a mistake when they pigeon-hole themselves like this. There are times to be sellers of options, and there’s times to be buyers of options.
If volatility, which is one of the key components in pricing options, is high and the opportunity is right, then I’ll sell options. If volatility is low, and the opportunity is right, I will buy options.
It’s my feeling that to be allergic-to use an expression-to buying or selling options is-it’s a mistake. You need to find the best trades, no matter what your style is.
Steve Halpern: You’ve mentioned one strategy you use as following where large options purchases are made.
Could you highlight some of the other strategies that you follow?
Jacob Mintz: Sure, I try to have as many trading strategies as possible at my disposal. Now that trading is electronic and we are easily able to access any stock and any option with a click of a button, there are limitless opportunities. I try to keep an open mind about my strategies.
In general, I like to spread my risk. Not all of my trades are going to be winners. Of that, I’m absolutely certain. If someone tells you that they are, I would recommend running in the other direction. When I’m wrong, I want to limit my risk.
One risk-defined strategy that I use is called an iron condor. It’s a slightly complex option strategy in that it involves trading four options at once; however, once understood, it’s a great way to create yield.
For example, Tesla (TSLA) had earnings just a month ago, and volatility and fear were extremely high. I want to take advantage of this fear by selling some volatility. With the stock trading around $135 the day before earnings, I put on an iron condor that made money if the stock stayed above $95 and below $180. This meant that I had $40 of room to the downside and $45 to the upside.
This trade worked great, as a stock that’s currently trading at around $160; however, there was a chance that I could have been wrong, but with an iron condor, I defined my risk. I knew my worst possible scenario if the stock moved outside of my ranges.
Steve Halpern: A lot of investors are scared of options if they think it’s too complex.
Could you explain how the average investor might comfortably use options in their investment strategy?
Jacob Mintz: Many investors feel that options might seem like an exotic financial instrument that they could never understand. What I can tell you is, I didn’t graduate from MIT or Harvard with an advanced degree in mathematics or physics.
I was a communications major from Miami of Ohio, but I put in the time learning the basics of what a call and a put is, and slowly built up to more advanced strategies.
I think options should be part of every investor’s trading playbook. A great way to hedge your portfolio to create yield in this zero interest rate environment, and gain significant market exposure and leverage with little capital at risk.
Steve Halpern: Could you give us a few examples of some current trades that you recommend, so that listeners could understand the types of opportunities they could get with the Cabot Options Trader.
Jacob Mintz: Sure, I’ll first talk about the type of trades I recommend through Cabot Options Trader. When I took over this role as options editor, I made it my objective to share with my readers my experience and knowledge of trading for the past 15 years. I hope everyday to enrich my readers’ options knowledge and brokerage accounts.
At Cabot Options Trader, we have a wide range of investors and traders, with varying levels of experience and options. Therefore, I send out many educational pieces every month explaining the nuts and bolts of trades and the risks and rewards.
Many of my readers just want simple call and put recommendations and I offer these when the risk and reward is right; however, when I feel a more complex strategy is needed, I offer my advanced strategies, such as call and put verticals and iron condors.
Many of my novice option readers were initially scared of these more advanced strategies.
However, I showed them what our best and worst scenarios were in these strategies and how to initiate the trades. They became more and more comfortable and now they’re moving from novice option traders to advanced options traders.
A couple of examples would be, we certainly have recommended the purchase of some SandRidge (SD) calls. Several large investors felt that the company was mismanaged for the last couple of years and the CEO was essentially forced out.
In the last year, some of the largest hedge funds in the world have initiated positions in SandRidge, including famed investor Leon Cooperman of Omega Advisors.
At the Delivering Alpha conference in July, Cooperman said that SandRidge has the potential to double, and the stock has the best risk/reward of his top ten stock ideas.
Also, recently I’ve been noticing a large call volume in the stock, which leads me to believe that other big investors also like the risk/reward in buying calls.
Another trade we put on recently was a bull put spread in Cree (CREE). The stock had dropped from $74 to $57.5 after a disappointing earnings release. I didn’t anticipate the stock would rally hard, but I wanted to put on a trade that would profit if the stock went up, didn’t move, or didn’t go down another 10%.
We sold the September $52.5 put and bought the September $50 put and received a credit of $0.44. If the stock stays about $52.5 by September 21 of this year, we collect our $0.44.
If the stock goes to $50 or below, we lose $2.06.
There certainly was risk in this trade, but I liked our odds and the stock not falling another approximate 10%.
Steve Halpern: Now, is this a trade that somebody could put on today?
Jacob Mintz: At this point, the spread has actually worked really well, so, you could still put it on, but you would not get the $0.44 still. I think it’s currently around $0.20. Now, with less than two weeks until the spread expiration, the fact that it’s trading near $60, and our spread is looking like it is a winner.
Steve Halpern: Is there something going out a little longer that could be of interest to our readers that they could act on now?
Jacob Mintz: In terms of another trade idea perhaps?
Steve Halpern: Yes.
Jacob Mintz: Yes, recently I recommended buying Dendreon, a January 3.5 call. This call expires January 17, 2015. Dendreon’s symbol is (DNDN). Also, recently got hit pretty hard with an earning miss, the stock fell from approximately $5.50 to-it is currently trading around $3.
I use long-term options when I think there’s a chance for a turnaround in a company. This January option doesn’t expire until January of 2015. I’ve given us approximately a year and a half for the stock to have a potential bounce.
Steve Halpern: Jacob, thank you very much for joining us today. We appreciate your insights.
Jacob Mintz: Thank you very much for having me. I appreciate it.
At the Cabot Wealth Summit last week, I put forth several options trade scenarios in a presentation titled, “Supercharging your Portfolio with Options.” In the presentation, I showed how you could combine Cabot analyst’s stock picks such as Exact Sciences (EXAS), General Motors (GM) and Home Depot (HD), with options strategies, such as Buying Call Options, and Buy-Writes/Covered Calls, to produce big returns.
The example that got the biggest reaction from the crowd was when I combined a stock from Crista Huff’s Buy Low Opportunities list with the sale of a put. As I broke down the trade, I could see the conference attendees were getting excited by this strategy.
The next morning, a conference attendee stopped me at breakfast and told me, very politely, that she thought that my example of selling a put on Crista’s recommendation, Cimarex Energy (XEC), was a “shell game.” While I’m not exactly sure what she meant by that, I assume she was implying that the options trade was too good to be true. I promised her that put selling is not a shell game, and is in fact a great options strategy to buy a stock lower than it’s currently trading.
How the XEC Options Trade Works
Cimarex Energy is an independent oil and gas exploration and production company that has struggled in 2017, losing 21% year-to-date. However, Crista considers the stock a great Buy Low Opportunity at the current levels.
With the stock trading at 102 and Crista willing to buy the stock at this level, I showed the conference attendees that we could execute an options trade in which we could potentially buy the stock even lower if it continues to fall. And if the stock price didn’t fall, we have essentially written insurance on the stock and would collect a nice premium.
With the stock at 102, I broke down the risks/reward of selling the October 100 Put for $3.
So, what does this mean?
Put selling is a short volatility trade. If the stock does not fall below the strike in which the trader sells, the trader collects a premium.
If the stock does fall below the strike, the trader who sold the puts, would be forced to buy the stock at that strike price.
Essentially, the trader doesn’t think the stock will fall, but if it does, he is willing to buy the stock lower.
So, if I sell the XEC October 100 Put, and the stock closes ABOVE 100, which is the put’s strike that I sold, the put expires worthless. And I collect the full $300 premium. In other words, if the stock closes at 100.25, or 101, 110 or anywhere above 100, I collect that $300.
If XEC closes BELOW 100, the person to whom I sold the put will exercise his right to sell me the stock at 100. That’s the level at which I wanted to own the stock, so I’m ok with that scenario. Also, because we collected that $3 with the sale of the put, our breakeven on the stock purchase is actually $97.
Seller of 15,000 salesforce.com (CRM) October 92.5 Puts for $0.65 – Stock at 95.6 (trader willing to buy 1.5 million shares at 92.5)
Seller of 7,000 Service Now (NOW) October 110 Puts for $1.10 – Stock at 117 (trader willing to buy 700,000 shares at 110 – similar to trade made on 9/7)
Seller of 15,000 Ctrip.com (CTRP) January 50 Puts (exp. 2019) for $4.30 – Stock at 53.75 (trader willing to buy 1.5 million shares at 50)
My read on widespread put selling is that the big trader/traders are not putting on high conviction trades at the potentially elevated levels in the market, but they are willing to buy stocks like these (and XEC) on dips.
I constantly evaluate my options portfolio based on two main factors: time and delta. What do I mean by this?
Time is the most important and easiest to understand. As an option is approaching its expiration, time is running out on the options life. For example, our September options expire next week, so next Friday afternoon, September options will cease to exist. Because of this, September options are on the top of my radar, followed by October, November, and so on.
Here’s how I rate our positions in order of importance based on time:
Anheuser Busch (BUD) September Position
Cypress Semiconductor (CY) September Position
Micron (MU) October Position
Bank of America (BAC) October Position
Pulte Homes (PHM) October Position
S&P 500 (SPY) January Position
Sprouts Farmers Market (SFM) January Position
Kraft Heinz (KHC) January Position
Johnson Controls (JCI) April Position
Delta is harder to understand. The delta refers to the expected price change of an option, based on the stock’s movement. The two most important components of determining an option’s delta are the time left until the option expires and odds of the option finishing in-the-money.
Let’s use our Anheuser Busch (BUD) September 115 Calls to illustrate.
Regarding the time component, our Anheuser Busch (BUD) calls expire next Friday. Time is running out on the option.
As for the odds of the call finishing in-the-money component, as of this afternoon, the BUD September 115 Calls are $6 in-the-money.
Because time is running out, and because the option is so far in the money, this option has a delta of 100. Why?
It is assumed that the call will finish in-the-money in the next week, and thus it is assumed we will exercise our option to buy the stock at 115. And because of these assumptions, our calls have a delta of 100, and will move $1, for every $1 the stock moves. If the stock goes up $0.50, our September 115 Calls will move higher by $0.50. If the stock drops $2, our option will lose $2.
Conversely, our Cypress Semiconductor (CY) position is not in as good shape. Our call expires next Friday. And with the stock $1.30 away from the 15 strike, the call has a zero delta. Why?
It would take a big move for CY to rally from 13.7 to above 15 in the next week. The rally would have to happen REALLY soon. And because time is not on our side, and the likelihood of the stock rising above 15 is small, our call likely won’t start moving higher until the stock gets closer to 14.75. At that point, the call would have a better chance of finishing in-the-money.
So if I combine the time and delta factors, this is how I would rate my attention on my positions:
Anheuser Busch (BUD) September Position (highest delta and time component)
Micron (MU) October Position (stock at highs which is increasing delta component)
S&P 500 (SPY) January Position (on my radar, but has time)
Sprouts Farmers Market (SFM) January Position (on my radar, but has time)
Kraft Heinz (KHC) January Position (on my radar, but has time)
Johnson Controls (JCI) April Position (won’t be a real concern for months)
Bank of America (BAC) October Position (buy-writes have low deltas as they are somewhat hedged)
Pulte Homes (PHM) October Position (buy-writes have low deltas as they are somewhat hedged)
Cypress Semiconductor (CY) September Position (time and delta say this position is nearly dead)
Because of the time and delta of BUD, I’m laser-focused on the stock (making new recent highs this afternoon). Our position will move dollar for dollar with the stock, so I have my finger on the exit button should the stock drop. If you do not want to take the risk over the next week, and there is always gap risk because BUD is an ADR, you can exit your position today for a profit of approximately 120%.
I hope I did a good job of explaining a difficult subject matter. However, please don’t hesitate to email me if you have any questions.
Your guide to successful options trading,
Upon graduating from Miami of Ohio in 1999, Jacob Mintz trained under a trading legend on the floor of the Chicago Board of Options Exchange (CBOE). Working side-by-side every day for more than one year, this trading legend served as Jacob’s option trading mentor and helped him build a strong foundation that led to Jacob’s own successful career trading options. Learn More