Options

A lot of people I know has started to trade options.  It is a good way to make A LOT of money in this volatile market.  Problem is that people tend to open one sided positions.  That is a recipe to lose a lot of money.  As any trades, hedging is key – especially when you are dealing with derivatives.  So how should I make money when the market is swing 3-500 points a day (probably more if you did the math from day low to day high instead of the open to close delta)? 

You can hold (long) puts or calls, or you can write (short) puts or calls.  The combination of these can limit the losses; however, it will also limit your gains.  As volatility increases in the market, the premium for puts and calls also increase.  As a writer of calls or puts, you can make good money from the premiums.  However, the market can totally break on you.  But I think it is still an advantage to write naked puts on some good companies.  Here are the reason why:

1)      In this down market, put premiums are high, even with front month expiries. 

2)      Solid companies that are knocked down can, in the long term, rebound.  Think companies like GE, COKE, WMT, IBM, etc.  Remember to do this research before picking what stock to write naked puts. 

3)      If you are assigned by the exchange, the premium you got from writing the naked put let’s you buy that stock cheaper than the strike.  I recommend writing a longer expiry put since the time decay with high volatility will give you the most premium. 

4)      When you are assigned the shares, you can then turn to covered call write and hold the shares for long term investment.  Remember, we are not traders.  We are investors.  There is a clear line that separates a trader and an investor.

Strangle or straddle are good strategies to use in this market as well, but the premium on the two sided trades can get pretty high and you pay 4 commissions total for these type of trades.