Skip to main content

Use Options to Make Direction Bets

Options are good for risk/reward plays in highly volatile markets.
  • Author:
  • Publish date:
Comments

I have been investing for over three decades now. Over that time, I have tried to consistently hone my skills to become a better and more profitable investor. Part of that is a constant evolution of being able to deploy more and more of the tools in my toolbox for the right investing situations. Options have become a much bigger part of those tools over the past decade.

I have found I initiate almost as many or more option trades these days than I do pure equity positions.  I find this part of the toolbox particularly useful for taking directional bets and setting up asymmetrical risk/reward plays in highly volatile parts of the market.

I have learned to love out of the money bull call spreads to action the latter. This involves buying an out of the money call and simultaneously selling an even further out of the money call. This helps reduce the cost of a position and defines both the upside and downside of the spread.

I had dinner with a good friend with almost 40 years of experience in the commodity space the other night. For the first time in many, many years he is bullish on gold as well as lead and tin. 

For gold, he believes the yellow metal, which currently trades just over $1200 an ounce, will see a significant rally by year-end. My friend believes falling production yields on the supply side and increasing interest from China and India in the metal as they grow weary of fiat currencies on the demand side will see gold at $1400 to $1500 an ounce by the end of 2015.

I respect my friend's opinion in this space and I have profited from his insights in the past. I also have no interest in holding gold or a straight equity position in a gold ETF or any of the gold mining stocks.  However, I also want to bank some asymmetrical profit if my friend turns out to be right. This is where bull call spreads can come in quite handy.

Late yesterday I took a position in the SPDR Gold Shares (GLD) using this strategy. I initiated numerous Jan 2016 $125/$135 bull call spreads. This means I bought the $125 strike position while selling the $135 strike position. This cost me $1.55 a share, or $155 per contract. This is my defined downside. If my friend is right and gold is above $1350 in early January I will pocket $845 a contract ($1000 - $155) and owe him a very nice steak dinner.

Obviously this position has huge upside if correct and limited downside if the yellow metal remains in the doldrums. I could also have done something similar with any of the big gold miners like Barrick Gold (ABX)that has good liquidity in the options market. 

What I like about this strategy is I do not have to hit too many of these over the course of the year to make it highly profitable over time. It also requires little outlay on my part, keeping my powder dry for more straight-up, buy-and-hold equity positions on any significant dips in the overall market.

This is a tool I wish I had used more often earlier in my investing career. Investors who want to enhance their returns and their ability to mitigate risk should put it in their own investing toolbox.

At the time of publication, Bret Jensen had a long position in GLD.