Last week we made a little trade that doubled our investment in one day. Every month, a similar opportunity presents itself. Of course, it doesn’t always work out this nicely, but it seems to do well most of the time. Today, I would like to share our thinking with this trade.
An Interesting Post-Expiration Play
Many investors are aware of a couple of phenomena which seem to prevail in the market. The first is that the Monday after the regular monthly options expiration is generally a weak day for the market. The second is that the first trading day of each month is usually a strong day.
When other indicators also suggest that these generalizations might hold true, it might be a good time to make the outright purchase of a put or call.
On Friday, July 20, the regular monthly options expired. At that time, the market was also in an overbought condition (one of the indicators that we follow, RSI, was over 70). Overbought conditions are not nearly as important indicators as are oversold conditions, but they are something to consider nonetheless.
Our favorite ETF to use when buying options is the Russell 2000 Small-Cap (IWM). It seems to fluctuate in the same direction as SPY, but by larger percentages. On expiration Friday, with IWM trading right around $79, we bought a Jul4-12 Weekly 79 put for $.85. Actually, we bought 5 of them, shelling out $425 plus $6.25 for commissions (our broker, thinkorswim, charges Terry’s Tips subscribers a flat $1.25 per option contract).
On Monday, we placed a limit order to sell those puts if the price got up to $1.73. The stock tumbled almost $2 on that day, and our order executed. We were delighted to double our money after paying the commissions. After commissions, we made a profit of $427.50 on our initial investment of $425.
We could have made more if we had waited a little longer, but we’ll take double our money any day. Selling when we did ultimately proved to be a good idea because by the end of the week, our puts expired worthless when the stock rose to above $79.
Last week was a great one for anyone who bought either puts or calls. Option prices were low (lower than they are this week) and volatility was high. If you were willing to accept a moderate profit on your option buy, you could have done well either with puts or calls last week.
For most of the past couple of months (and all of last summer as well), option prices have been lower than the actual volatility of the market (SPY, and IWM). This means that a good strategy has been to buy options rather than sell them (which is our usual preference).
This week, the first trading day of August falls on Wednesday. We might be inclined to buy a call on IWM because the market is often strong on that day. However, option prices (VIX) rose 5% Monday morning so options are not quite so cheap this week. With the big run-up in the market last Friday (SPY gained almost 2%), we are probably due for some weakness soon, so we are probably not going to buy a call this time around. We like to see other indicators which support our buying decision, and we don’t see any at this point in time. (RSI is neutral, for example.)
Buying options is still probably a good short-term idea, but sometimes it is safer just to sit on the sidelines for a week or so and wait for a more opportune time.