Options Trading Strategies When Your Stock Is Down 5%

| October 2, 2015 | 0 Comments

options strategiesOptions Trading Strategies When Your Stock Is Down 5%

Market volatility has picked up considerably since the stock correction from late August.  The VIX, a popular method of measuring market volatility, has been trading above 20 for well over a month.  In comparison, the 200-day moving average is around 16.

We’re essentially seeing volatility levels more common in a bear market.  Does that mean we’re in a bear market?  It’s hard to say for sure, but the economic data doesn’t support it at this time.

Regardless, there have been several big down days lately.  And, there are plenty of stocks which have dropped 5% in a week, or even a day.

Obviously, if you’re long the stocks that have been dropping like lead weights, you’re not a happy camper.  Fortunately though, options can help you reduce significant downside risk.  And in some cases, you may even be able to profit from the situation.

I’ll get back to that in a minute, first a quick aside…

For those of you with a deeper interest in options volatility, I’ve often written in the past about volatility and options trading.  Feel free to check out this article to learn more about why volatility is important.

Okay, so what options trading strategies can help you salvage your portfolio?

Let’s look at an example of a stock that’s dropped over 5% in a week.  Here’s Bank of America $BAC:

a chart of a stock dropping over 5% in a day, $BAC

As you can see, the August correction took its toll on BAC.  It dropped about 15% in just a couple days.  Most likely, if you owned the stock during this tumultuous period, you were concerned about the performance.

However, that doesn’t mean BAC is a bad stock.  On the contrary, it’s a generally a good company which only dropped because of market conditions.  It wasn’t anything stock specific.

So the question is, now what?

That’s where options come in.

There are several options trading strategies which you can use when your stock is down big.  Some are more geared towards risk reduction, while others are meant to help recover lost gains.

For example, buying puts is a straightforward way to hedge your stock from further downside.  Put buying is a peace of mind trade meant to help you sleep better at night.  Conversely, you can buy calls if you think your stock is going to go back in the relatively near future.  Essentially, call buying will help amplify your returns on the way up.

Of course, you could buy both puts and calls if you think the stock is going to move but are not sure what the direction is going to be.  Straddles and strangles both can serve the purpose in this case.

On the sell side of things, both calls and puts can once again be used.

If you feel your stock has gone about as far down as it’s going to go, you can sell puts below the current price.  These puts can help generate a yield which will serve to build back gains over time – even if the stock doesn’t move for awhile.  If the stock does drop below the short put strike, you’ll be on the hook for more shares… but that may be a good thing if you’re in for the long haul.

On the other hand, you can sell calls against your long stock and create a covered call situation.  In this scenario, you earn a yield-like return on your short calls if your stock is neutral, while making additional money as the stock rises towards your call strike.  The calls also provide some cushion to the downside.

So there you have it.  That’s several ways to utilize options trading strategies if your stock drops 5% or more.  Options make it easy to mix and match your goals and risk tolerance and find the best fit for almost any situation.

Yours in Profit,

Gordon Lewis

Note:  Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com.  You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.

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Category: Options Trading Strategies

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.