Deep down, you knew it was coming… a sell-off.

The market’s bullish climb was never backed by positive economic news, technical data, or even common sense.

And now, as the market teeters on the brink, self-directed investors are facing even more uncertainty — we are entering a seasonally weak time for stocks.

Let me explain…

I’m sure you’ve heard the expression, “sell in May and go away.” You’ve heard it, and probably immediately discounted it as another useless sound bite. That’s a good instinct to have, but I recently ran a statistical test looking at the average return of the S&P 500 on a monthly basis over the last 60 years – and there’s some strong validity to the saying.

Here’s what I found:

As you can see, the above stats prove that the summer doldrums aren’t just a figment of Wall Street’s imagination. Stocks historically deliver near flat returns from May to October.

The Stock Trader’s Almanac carries the study a bit further. The trader’s bible states that a $10,000 investment in the S&P 500 compounded to $544,323 during the November-April period over the last 56 years, compared to lackluster $272 loss for the May-October period.

What’s more, every wealth-robbing market crash occurred during these months, including 1929, 1974, 1987, 2001, 2002, and 2008 — and most recently, last year, when the market sold off in August touching off a period of unprecedented volatility.

The months ahead could offer any number of obstacles for investors. But you shouldn’t be worried…

Because I have a strategy that can help you protect your portfolio from serious downside risks, like a market crash, and generate income no matter what happens. I call it:

“Stock market insurance”

This easy-to-implement options strategy allows you to take control of your portfolio and earn real returns regardless of which direction equities move.

You’ll no longer have to wait on the sidelines or hope for the market turnaround… You’ll be able to dictate, in your terms, when and how you want to make money with limited risk.

Trade Arena

Late last week I placed our first credit spread trade using weekly options. It was also the first time I introduced a weekly trade for The Strike Price. Weekly options, unlike monthly options, differ in that they are offered on a weekly basis (obviously) – so everything is accelerated. Up to this point my focus had been limited to contracts on highly liquid stock and ETF options. As I have stated numerous times in the past underlying equities with highly liquid options are a necessity when trading options because they provide us with tight bid-ask spreads. And tight bid-ask spreads mean fair prices without an edge to the market maker. Wide spreads can require gains of 15-30%, if not higher, just to hit breakeven. The universe of highly liquid ETFs with options is limited to roughly 40 ETFs in the Options Advantage service. For many of you, that is plenty.

But some of you have requested that we expand our universe.

All of our trades are based on having a statistical advantage, usually with an 80-85% probability of success. This 80-85% is key, because it truly doesn’t matter if the underlying of choice is an ETF or individual security. As long as the underlying’s options are highly liquid, as represented by tight bid-ask spreads, your chance of success is the same.

So, per your requests, I decided to add another 40 or so highly liquid optionable stocks to the mix.

One of the stocks on the list is Vermont coffee maker Green Mountain Coffee Roasters (GMCR), a company near and dear to my heart only because I frequent its flagship coffee shop in Waterbury, VT several times a week. But more importantly, the stock offers highly liquid options with tight bid-ask spreads.

So as most of you know, last week I decided to discuss a weekly bull put spread in GMCR.

I simultaneously sold the GMCR May weekly puts at the 39 strike and bought the 37 puts for a credit of $.30. At the time of the trade, the delta of the 39 strike was .15. This means that the probability of this option being out of the money (the stock price above the put’s strike price) at expiration (or the probability of success) was 85%.

A trade that offers a 15% gain in seven days with a probability of success of 85% is something I’ll trade any day of the week.

When I placed the trade, GMCR was trading at roughly $48.00, approximately $9 away from my short strike of $39. The expected move that the options market had priced into the stock was $7.20 at expiration. And $40 had acted as an area of strong support for several years.

Thus, the stock would have to move more than 19% to hit my break-even point of $38.70. And the options market told us that there was only a 15% chance of that happening.

Immediately after I placed the trade, the stock rallied. In fact, it closed at $49.52 on Wednesday, which increased the probability of success because the stock would have to fall even further to hit our break-even point. In fact, the chance of success on the trade increased to 88.7%.

Remember, as long as GMCR did not fall below our break-even of $38.70, the trade was a winner. But as we all know by now, GMCR fell prey to a catastrophic fall of close to 50%, resulting in a maximum loss. Just to put the move into perspective, the 30 strike for the May Weekly put option had a delta of 0.01 before the plunge. What does that mean?

Flip a coin 100 times. What are the chances that only one out of the 100 tosses fell as heads? Well, that’s exactly what happened in GMCR. With a delta of 0.01, the market believed that the chance of GMCR moving to the 30 strike was 1% … yes, 1%.

Indeed the move was an anomaly.

And it is the statistical anomalies that lead to losing trades when selling options. But they should be expected every so often because the probabilities provide us with the rate of success. Since our trades have an 80-85% success rate, we know that approximately two out of 10 trades will be losers. However, our losers are typically not max losers like the GMCR trade. In most cases, particularly when limited to ETFs, moves are not as profound, so max losers are infrequent.  That’s why I’ve focused on trading ETFs and not stocks within the Options Advantage portfolio.

To keep things simple and focused, I’ve decided to trade only ETFs in the Options Advantage portfolio. However, I will be sending out trade ideas from my list of highly liquid individual stocks roughly 3-5 times per month. This will provide those of you who prefer more activity the ability to receive more actionable ideas for your own options portfolio.

Let me conclude by saying that losses, while inevitable, are never enjoyable.  They hurt and they cost money.  But we all know they happen.  It’s what you learn from losses that matters most.  And what I’ve learned in my 15 years of trading is that you stick with what works.

Don’t let one bad trade throw you off your game.  I know that having a statistical edge trading spreads is a sound and profitable system.  I also know that it doesn’t work every time – no system ever does.  So I don’t plan to change how I go about finding the best edge I can find for my readers.  That’s always been my mission with and that will never change.

If you have any questions or comments, please feel free to email me at optionsadvantage@wyattresearch.com.

Until next time,

Andy Crowder
Editor and Chief Options Strategist
Options Advantage

— Andy Crowder - Options Advantage

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