[Options] Letting the Market Finance Our Ambitions

Sean McLaughlin
March 2, 2022

I feel like this has been the lead for many blog posts recently, but the trend continues: options volatilities continue to remain elevated across the board with $VIX holding above 30, and this makes me want to continue favoring strategies that are net short options premium.

But with the trade today, we're going to leverage options premiums to help us finance a bullish bet on NASDAQ stocks.

It started out with JC and I wanting to simply sell premium, but when we looked into $QQQ options it became pretty clear that we could get paid handsomely if recent lows end up becoming a pivot to higher prices and we took some put premiums to buy out-of-the-money calls.

This strategy of selling naked options to finance the purchase of long calls is known as a "Risk Reversal."

And thanks to the high implied volatility in $QQQ options, we can sell out-of-the-money puts comfortably far away, near a level of recent support.

So here's what we're looking at which $QQQ chartwise:

 

The closing price on February 23 near $330 feels like a pretty significant level for us. The Q's gapped lower the next day but violently rejected those prices by rallying incredibly strong that whole day. Knowing this, we'll give ourselves some room and anchor our short puts at the $325 strike.

Here's the Play:

I like selling $QQQ April 325 puts and buying an equal amount of April 360 calls for any net credit I can.  This means I'm naked short puts and therefore this trade has theoretically unlimited risk and will require margin. Due to this, we'll trade this position small and manage our risk closely.

I was able to put this trade on for a net 20cents credit. But the net amount of the credit is not all that important. It's not what we're playing for. But I do prefer to have some kind of credit in this trade.

The goal of this trade is to ultimately convert this position into a straight long calls play. Here's how:

If $QQQ goes our way, we'll look for any opportunity to sell half of our calls and use those proceeds to close our entire short puts position. For example, let's say my position size is 2 short puts and 2 long calls. If the QQQ calls increase in value to $10.00 per contract and the puts decrease in value to $5.00 per contract, I can sell one call for $10 and buy to close the two puts for a $10 total, for a net cash flow of zero. And then I'll be left with one call that didn't cost me any money. This is what we call a free ride!

Then we'll just treat the trade like any other long call trade. We'll hold into April and then make a decision whether or not to continue holding then. If the options are out-of-the-money on April 1, then we'll close the trade down for whatever we can get and book the small win. If QQQ is above our long call strikes of 360, then we'll continue holding as long as QQQ doesn't break any nearby support (3-5 day low).

Any close below 325 invalidates this trade and I'll look to exit the trade near the open on the next trading day.

If you have any questions on this trade, please send them here.

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~ @chicagosean

P.S. We do trades like this regularly. If you'd like to leverage Best-in-Class technical analysis into smarter directional options trades, try out All Star Options Risk Free! Or give us a call to learn more: 323-421-7991.

 

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