Why Safe Trading Strategies Are So Important In This Market
Many investors are nervous right now.
And that’s understandable. The decline that coincided with the economic shutdown was deep. It led to large losses. But that made sense, because the economy was in freefall.
The recovery since then seems almost irrational. Investors don’t want to miss out on gains, but the gains seem to be ignoring the slow reopening of the economy.
I’ve been getting emails lately from subscribers telling me that they’re nervous. A great example is a note I received about a position we closed yesterday. The subscriber wanted to know about an options trade we had in place that was set to expire next month.
“It’s been sinking steadily for the past four days and with another day like today it will be close to our strike price. Do we sit tight and take quite a loss?”
I wanted to use this email to highlight the fact that there are a number of variables involved in options prices. (This article does a pretty good job of explaining the factors involved.) But the most important thing to know is that the relationship of the option price to the strike price varies over time. A large potential loss will often become a gain or a small loss closer to expiration as the volatility and time components of the option price decrease.
That’s perhaps the most important idea to keep in mind as options prices change. A temporary spike in volatility can affect options prices. But as that factor declines, the price of the option can decrease suddenly. For aggressive traders, temporary volatility spikes can be trading opportunities. As conservative traders, we tend to ignore these spikes.
There are also news events that will affect the positions we hold. In the case of the trade in question, which was on the iShares 20+ Year Treasury Bond ETF (NYSE: TLT), the meetings of the Federal Reserve will affect the position. (In case you missed it, I wrote about how the virtual certainty of a low-interest rate regime has been enabling us to eke out small wins with TLT in this piece.)
The Fed is expected to remain on hold for the rest of the year, and that means TLT will be volatile but should remain in a narrow trading range. The chart below shows the bond market is pricing an 85% probability there will not be any changes to interest rates before the end of the year.
Source: CME Group
Overall, this made TLT a safe trade, provided we stick to our strategy and ignore the short-term volatility. And sure enough, the position offered a chance to lock in gains earlier this week, which is why we took it.
The reason I bring this up is because even though this is a crazy time in the country (much less the market), there are still some things that are true. In this case, the factors that affect options prices are still true. As long as we remember that and stick to a proven system, we should be able to come out ahead more often than not.
How I’m Trading Right Now
With all this in mind, I recently issued a new trade recommendation for Automatic Data Processing, Inc. (NASDAQ: ADP).
ADP is on an Income Trader Volatility (ITV) “buy” signal.
The stock has strong support near $130, as the chart shows. Support for the stock comes from its dividend. ADP has increased its dividend for 45 years in a row. That means the stock is attractive to income investors.
The chart below shows that buyers rush into the stock when the yield moves above 2.5%.
Based on the current payout of $3.64, the stock has fundamental support at $145. That means traders could simply buy the stock outright and have a reasonable degree of confidence in a successful position.
Of course, that’s not exactly what we do as options traders. I won’t give away the exact details of our trade, but suffice it to say there’s an opportunity (based on technicals and fundamentals) to sell puts on the stock that could allow you to earn 3.5%, in 38 days.
Another strategy you can feel confident in right now is with what I call “bonus dividend” trades…
While most investors sit and wait for their dividends to roll in, we don’t. And we even make these trades on stocks that don’t pay regular dividends at all.
We’ve been making trades like this for years — and my readers have been earning hundreds (even thousands) in regular income, like clockwork. That’s the power of my “bonus dividend” strategy.