The Wuhan coronavirus is the classic black-swan event that almost no one anticipated and that everyone must confront. The stock market initially reacted badly, but now the virus has seemingly killed the black swan.
Still, investors must confront the widespread belief that the U.S. stock market is unstoppable and seemingly immune to black swans. Maybe it’s because interest rates are so low and investors feel not buying stocks is riskier than buying stocks. Or maybe it’s because President Donald Trump increasingly is seen as the stock market’s guardian.
If he wins a second term, as seems likely, many investors think stocks could benefit from his pro-market policies as the president dominates Washington in ways unseen since Lyndon Johnson’s presidency.
Ultimately, the perception of an all-powerful stock market becomes extremely dangerous, as it spreads apathy and greed, which are the personal black swans that haunt every investor and every portfolio.
Rather than suggesting that investors sell stocks, incurring capital gains, to buy call options—the standard options strategist’s answer to high stock prices and low volatility—it is better to focus on something rarely discussed: the discipline of taking profits. Many investors are sitting on loads of winning stock and options positions and few have a framework for handling gains.
If you have made a 100% gain on a stock or options investment, take profits even if there is more money to be made. If a position is up 90%, don’t risk an extraordinary return holding out for the remaining 10%. Many things can destroy a profitable options contract. Besides, put and call prices seem to decline faster than they increase.
Consider Tesla (ticker: TSLA), which has produced substantial profits since we wrote about it less than a month ago.
Tesla stock often seems powered by the broken dreams and shattered fortunes of skeptics and short sellers. In mid-January, when it was trading around $537.80, we recommended a “risk reversal” strategy and a call spread to profit from the stock trading above $550 by June or $600 by July.
On Tuesday, Tesla’s stock surged some 20%, reaching an all-time high of about $969. At the time, the June call was worth $419, well above the $17 position cost. The July call spread was worth $49, an almost 90% return. Hopefully, readers realized some profits somewhere near the top. If they didn’t, it’s time to reset the positions. The new trade works for investors who did the old trade, as well as for others interested in harnessing Tesla’s extraordinary volatility.
With the stock around $728, aggressive investors can consider selling Tesla’s May $675 put for $90 and buying the May $745 call for $115. This risk-reversal strategy positions them to buy the stock at $675 and to participate in rallies above $745. At $900, the call is worth $155. The risk: The stock falls far below the put strike price, forcing investors to buy it back at top dollar or to buy the stock at a premium.
The May expiration was chosen to capture Tesla’s next earnings report, which will likely be released in late April.
So far this year, Tesla’s stock is up 74%. During the past 52 weeks, the stock has ranged from $176.99 to $968.99.
This trade is aggressive. If you cannot handle extreme volatility and cannot afford to lose all of the money, don’t consider it. For those who are cashing out extraordinary profits, the new position is like playing with Mr. Market’s money.
To be sure, Tesla’s stock performance will attract every two-bit investor, odd-lot trader, and hedge fund jockey looking to make a name. This adds a wild card into the trading equation because many hands on a big, hot stock often precedes instability.
Yet fear is one of an investor’s true friends. When markets sink, have a plan to buy good stocks at great prices, just as you should have a plan to sell good stocks at great prices when markets surge.
Don Kaufman delivers what readers are calling 'HIS BEST YET!' In this exclusive Guide, Don will give you ALL the secrets he's taught millions of other traders to help guide them along in their successful options trading journey...
Now, this is NOT for those who only want to make a HALF attempt...nope...this is ONLY for those serious about becoming a better trained, more profitable, and long term options trader!
If that's YOU...Download Your Copy below: