[Click the image above to watch Dan's video; here is the transcript.]
I’ve had lots of questions on how to trade the markets during the Coronavirus outbreak. Should we sit it out? Should we be all in? Should we short everything? It can be nerve-racking to know what to do, so I’m going to share my plan.
Here are my top 3 trading strategies for the Coronavirus market.
#1 Strategy: Selling puts to scale in
We don’t know how the market will continue to play out through this viral outbreak. We could recover quickly or we could have a market crash or we could see anything in between. We just don’t know yet the extent of the human impact or the economic impact potential until we see how quickly and how far the outbreak will spread.
One thing we do know is that history shows when there have been market crashes, they’ve nearly always been preceded by an unexpected catalyst never seen before and artificially low interest rates. Is a crash within the possibility of what could play out? Yes.
However, history also shows that following crash scenarios, the market is almost always higher within 12 months. Meaning level-headed investors who sell overpriced puts and get assigned to accumulate long-term buy and hold positions can profit big time. It’s an opportunity that maybe comes along every decade or so.
And the great news with that strategy is if it’s not a crash and you accumulate stock from short puts, you simply make your return faster.
#2 Strategy: Short-term over-bought and oversold breakouts
This is a market that can make big moves fast. It’s nice to get on the right side of those moves. But it can be tricky. So it’s important to have a solid signal system using indicators to decide when to buy calls for a breakout to the upside and to buy puts to a breakdown lower.
We can use slow stochastics, and support and resistance levels to trigger entries. In fact, there are a number of breakout triggers that can work. But here, I’d like to focus on the most important part of a breakout strategy in this environment. The management.
Part one is it’s essential to use stop losses. When this market runs, the moves can be huge. Get on the right side of one and profits can be enormous. So getting out with a small loss on a loser should be an easy pill to swallow. Huge wins and small losses work.
Part 2 is profit taking. Though many of us are indeed in front of our trading platforms all day long, the market can move really fast. It’s a pity to miss profit opportunities. So, I put my exit orders in immediately following my entry consummation. I’ll put in an order to sell half at a reasonably good fill price, a profit of anywhere from 50% to 100% on a long call or put. Then I’ll put in an order to sell more (half or all of the remaining) at a 200% to 500% profit. And, yes, these numbers are possible in this market. And with a breakout strategy, we’re looking for this sort of price action.
#3 Strategy: Buying straddles
Buying straddles can be very profitable in markets like these. I’ve traded a good handful this past week and plan to do more if volatility keeps up. The key is not to overpay. I like buying straddles on a pull back when implied volatility falls. Options simply get cheaper and when the stock or ETF makes its move, it doesn’t need to move as far if you pay less for the straddle.
Yes, I like to look at the implied volatility to compare it to historical and to logic out fair value. That’s essential. But I also take a simplistic approach.
I look at a chart and get a feel for how much the underlying stock can move. Then I look at how much the straddle costs now. Then I expand the option chain and see how much the straddle would be worth if the stock or ETF makes a move of that size. If the profit is good enough, I take it. If not, I don’t. If I do take it, I sell half the position when the stock reaches that level and let the rest ride a bit. If I haven’t made money in 4 days, I close it to avoid time decay. It’s what I call a time stop.
For example, say there’s a stock at $200 that’s down from $230. It’s seen moves of at least $12 a day lately. And say the straddle is $11. I’ll look at the price of the straddle at the 188 strike (say it’s $15) and the straddle at the 212 strike (say it’s $13.50), and if I can expect to take a profit in one or two days on half the position (in this case of $4 or $2.50), that lowers my cost basis on the rest and gives it room to breathe.
It’s a great strategy and should keep working as long as the volatility lasts.
Founder and President
Market Taker Mentoring, Inc.