Loophole trades are well suited for the market volatility we’ve been experiencing these past few weeks, as financial and geopolitical uncertainties generate anxiety among investors.
In the previous issue of Power Profit Trades, I explained why Implied Volatility (IV) is a strong incentive for options traders to consider a loophole trade.
This issue, I focus on another compelling reason for the loophole trade: reduced cost and risk. I also recommend a specific loophole trade and explain its details in a training video embedded below.
When teaching my students, I run scenarios with them simulating a $25,000 account of which no more than 2% of the $25,000 is risked in any one trade. The math works out so that no more than $500 is risked on any one trade. In this scenario, $500 risk translates into a $5.00 option. One contract = the right to buy or sell 100 shares of stock, which means a $5.00 option equates to $500.
An Actionable Case Study
Let’s illustrate these principles with a LIVE case study of a loophole trade that starts Thursday, July 23 with The Priceline Group Inc. (NASDAQ:PCLN).
Here is the Money Calendar Pattern for PCLN coming into Thursday:
This upward move has happened 9 of the last 10 years, and for the last 7 years in a row. Also, there seems to be a bigger gain during this timeframe each year since 2011.
Here are the recent options prices for PCLN, with the stock trading just below $1,250 a share:
Take a look at the call options in the red box above. They’re quite expensive, for even the $1,300 calls, which are 50 points away from the current stock price. In fact, here’s what the $1,300 calls for August W1 look like at recent prices:
Click to Enlarge
There isn’t a strike above that is $5.00 or less, unless you go way out of the money. So how does one take advantage of an expected higher move in a stock like PCLN when it is too expensive for its risk profile?
Consider the loophole trade, which in this case would be a Call Debit Spread aka Bull Call Spread. This is where you buy a call option at one strike and sell another call (with a higher strike price) with the same month expiration.
Here is the trade published to Money Calendar Subscribers this week:
Click to EnlargePCLN Action to Take
Entry Date: July 23, 2015
BUY-to-Open: The Priceline Group Inc. (NASDAQ: PCLN) PCLN August 7, 2015 $1300 Calls (PCLN150807C01300000) AND SELL-to-Open: PCLN August 7, 2015 $1,310 Calls (PCLN150807C01310000) to create a PCLN August 7, 2015 Vertical Call Spread, for $4.00 or better.
Profit Taking Option: SELL-to-Close: The Priceline Group Inc. (NASDAQ: PCLN) PCLN August 7, 2015 $1300 Calls (PCLN150807C01300000) AND BUY-to-Close: PCLN August 7, 2015 $1,310 Calls (PCLN150807C01310000) to close the PCLN August 7, 2015 Vertical Call Spread, for $8.00 or better, or by August 6 at 3:00 p.m. U.S. Eastern time.
Notice the spread is more than 80% less than simply buying the call outright. This is the beauty of the loophole trade. Also note that PCLN reports earnings just before the trade closes; that’s why these options are so expensive.
The loophole is just another way to get into earnings without risking your shirt. The way to maximize profitability on this would be for PCLN to be above the $1,310 stock price at expiration. The profit then becomes $10 or $1,000 and your ROI results in that 150% based off the limit of $4.00.
The caveat to this type of trade is your upside earnings potential is capped, because no matter how high PCLN goes, the most that can be earned is 150%. Reduced risk means reduced reward. However, if you could reduce your risk and incur less out of pocket cost and still have a real possibility of a +150% return on your money, could you live with that? Of course you could!
The Priceline Loophole Trade: Your Training Video
Here is a video in which I explain exactly how (and why) to execute our Priceline loophole trade, step-by-step. Click the play arrow below, then easily access the video by logging into your account and clicking the Media icon.
To recap, the loophole trade generally allows for:
- Trading an expected move despite high IV, without having to just pay for the deemed overpriced option;
- Reducing the cost to trade, thereby reducing your risk; and
- Reducing potential loss, if the trade works against you.
Now when you read a loophole trade recommendation in Power Profit Trades, you will more fully understand why I chose to go that route.
When this choppy market eventually calms down, I will get simple again – as in, simple calls and simple puts. But as today’s markets rise in fear and uncertainty, I will occasionally rise up to the loophole trade – to reduce your cost, risk and stress.