Stagnant Markets
Sep 15, 2010
Stagnant Market

The stock market has not been very volatile over the past few months.  True, it has made some decent one day moves, but they are not repeated and they have been in opposite directions.  Unless your timing was outstanding, it has been difficult to make money as either a bull or a bear.

When you trade stocks, the best you can do is own the best stocks based on value and anticipated growth.  If you are talented in finding good opportunities, you can earn money in markets such as these.

When using option strategies, a trader can proper when the markets move within a range.  The big question is: How long will this situation last and what are the risks and rewards of making a play that depends on just how large that trading range will be.

Betting that this range -bound market will end soon

A trader can buy puts and calls, and hope for a gigantic move.  This type of play often loses, but the possibility of large rewards makes this a tempting choice.  We all know this stagnant market cannot last forever, but options have a limited lifetime, and if you make this play, the market must move fairly soon, or else you incur a loss.

Another way to play for a big breakout is to buy put and call spreads.  Choose out of the money spreads that don't cost too much, but which are not so far out of the money that there is no chance you will collect.  This is a difficult play to make because the most likely result is the loss of every penny invested.

The other side

On the other hand, you can take the opposite approach and sell puts and calls (sell straddles or strangles) or sell those put and call spreads (iron condor).   The trader's chances of success are much higher with this approach, but the potential loss is larger than the potential gain, and many conservative traders will not touch these plays.

Knowing that most investment clubs tend to be on the conservative side, the purpose of this post is to be certain that you are aware of these plays - if you choose to make one.  The important risk management factor is trading an appropriate number of spreads.  Calculate the maximum possible loss from the iron condor trade, or estimate the loss potential when selling strangles, and then decide how many options you can afford to trade.  Do not allow a large loss to damage your account.  It's okay to make one of these market-neutral plays when the odds are on your side and the maximum loss is small.

Mark D Wolfinger

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