This week, we’ve been talking about volatility. Volatility plays a massive part in any option trade’s success.
Ideally, if you get the trade direction and volatility right, you can bank significant gains.
Yet even if you only get the volatility part right, you can still book a tidy profit. Members of One Ticker Trader had the chance to pick up a 15.8% gain in less than a week, with direction playing little role.
So let’s dive in to see how the trade played out…
The chart below is SPDR Gold Shares ETF (GLD) – an ETF that tracks the gold price.
After topping out late January, gold reversed sharply, losing 21% in just three days. Then, after steadily grinding higher last month, it rolled over and dropped again.
GLD bearishly gapped below its 50-day moving average (MA, blue line), dipping toward oversold territory. Check out the chart…
SPDR Gold Shares ETF (GLD)
Source: e-Signal
Gold is not something I hold long-term. I just don’t see fundamental value. It can cost money to hold, and it doesn’t pay out a dividend. That said, I’m always happy to trade gold for a short-term profit.
That’s what we saw with our GLD trade…
The Relative Strength Index (RSI) was approaching oversold territory, and GLD was way overstretched past its 50-day MA. The chart was indicating a potential rebound. Plus, GLD was approaching the same level it reached after its huge sell-off in January (before it steadily recovered higher).
So we bought a GLD call option on March 19 for $2.92 to capture that anticipated move. That equates to $292 per contract (an option contract is for 100 shares). A call option typically increases in value as the price of the underlying shares rises.
This is why options are such a handy tool…
They allow you to gain exposure to a potential move at just a fraction of the cost of buying the underlying shares. What’s more, your risk is capped at the premium you paid for your option.
As the chart shows, GLD finished the day near its highs. But then it drifted lower over the following few days. At that point, our trade was underwater…
Take another look at the chart…
SPDR Gold Shares ETF (GLD)
Source: e-Signal
As the RSI rebounded out of oversold territory (red circle), the anticipated up move began. But GLD had only traded back to around the same level as when we entered the trade.
That’s where volatility played a special role…
We saw a sharp rise in volatility due to a huge swing in the physical gold price (from $4,536 to $4,098 on March 23).
That rising volatility flowed into GLD options, sending premiums higher. We were able to close out the trade on March 25 at $3.38 (or $338 per contract) – a 15.8% gain in just six days.
To be clear, we generated this profit using options. Because options use leverage, they magnify both profits and losses.
And because options expire, they can expire worthless if your anticipated move doesn’t pan out in your time frame.
Yet as this trade highlights, volatility can play a big part in the success of your option trades. As long as volatility rises quickly enough, you can profit even if the stock’s direction hasn’t moved much in the right direction.
In this case, rising volatility enabled us to bank a 15.8% gain in less than a week. And as volatility begins to move dramatically this year, I expect it will play a big role in more gains to come…
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
P.S. This is just one way I use volatility to extract profits out of the market…
Yesterday, during my AI Chaos to Cash special event, I shared how we’re using the volatility from the unwinding of the AI trade to generate regular profits with the help of one of my favorite options strategies.
If you missed the live event but would like to check out the replay, all you have to do is click here. I encourage you to do that quickly, as it won’t be available for long…
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
