What do stocks do when they go out of favor?

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What do stocks do when they go out of favor you ask?  As I gear up for our Master Class in long term option trading I find myself gravitating toward the drug stock sector.  Why?  Well, because I don’t think it is going to get better in that sector any time soon.  When I say that phrase to myself it means there is a particular type of trade and duration that is favorable.

Realized volatility gets very low

The first thing I look for is some new volatility lows in the name.  It is not often whole groups of stocks go out of favor but that usually means the interest in the options is close to 0.  Realized volatility tends to get real low as liquidity dries up and players go away.  Implied volatility gets real low as well.  What I like about this setup is the low penalty to buy options in the long term.   Most trades ignore options over 6 months because they don’t have the patience for them.  For someone with options ADD there is a solution.

Chart from Cboe Livevol Pro

Buying cheap volatility is best

The solution is to write short term options against long term options.  Well you say that will never pay!  Au contraire mon ami!  The decay profile of a 2 week option and a 6 month option is vastly different.  If I asked 6 months ago what would have happened over the course of Nov- Mar few people would have guessed a 20% drawdown in the QQQ at some point.  The trick is creating a position that pays the rent but does not take oneself to the woodshed should some horrible occurrence happen.  That is easily something some can learn

The Trade

I like longer term strangles to own in stocks like GILD but ratio a sale of options against them.  Rinse and repeat and make sure to own more contracts than sold.  This keeps the trip to the woodshed for someone else.  You can hear me talk about the strategy on TheOptionsInsiderRadio on today’s podcast.

Positions in GILD, QQQ

Follow Andrew@optionvol

Foillow Mark@optionpit


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