First-Class Stocks and Correlation
Another criterion I’m looking for in Rocket Wealth is whether or not the instrument is part of an index, and if so, is it correlated with that index?
There are several reasons we look for stocks that are included in, and correlated with, an index.
We are primarily looking to place Rocket Wealth trades on what I call “first-class” stocks, and if a stock is included in the SPDR S&P 500 ETF Trust (SPY), for example, then it’s more likely to follow the overall market.
That brings us to correlation!
Correlation is about more than just “these two stocks are both going up.”
It’s actually measured mathematically, which many traders don’t realize, and determines how much price movement is in the same direction and of the same magnitude.
There are several formulas used to measure correlation, and the one we use measures on a scale from -1 (perfect negative correlation) to 0 (NO correlation) to 1 (perfect positive correlation).
For our purposes, we are looking for the two instruments to be as close to 1 as possible, preferably above 0.8, but there is some flexibility.
Here’s an example of Amazon.com, Inc. (AMZN) and its correlation coefficient of 0.893 when compared to the SPY!
AMZN to SPY Correlation Coefficient – March 10
If that stock’s correlation coefficient is statistically significant, like with AMZN, then we can use the index to give us an idea of where the stock may be moving!
Here’s an illustration of how AMZN, which is usually positively correlated to the SPY, makes its way back when it deviates from the SPY:
The Right Side of Profitability
As I mentioned before, buying options before an earnings event means you could be getting in on the wrong side of profitability.
Options premiums can increase dramatically just prior to an earnings event, and that means paying much more for those options than you would have just a week or two before.
One way to profit around these earnings events is to sell puts.
Selling puts when IV is high means options traders are paying you the premiums, which are excessively high right before earnings.
Take the example chart from above for Stitch Fix Inc (SFIX).
Stitch Fix Inc (SFIX) with IV – March 10
Now, let’s check how selling puts the day before earnings would have worked out!
I did this during the LIVE session on Wednesday, and you can watch the Replay if you want to follow along!
Here you can see I am selling $10-strike puts on SFIX:
SFIX Selling $10-strike Puts on March 7, 1 Day Before Earnings
Now, fast-forward to today and you can see where our profit would be for selling those puts just prior to earnings:
SFIX Selling $10-strike Puts on March 7, 1 Day Before Earnings
That’s All There Is To It?
I’m not going to lie to you, there’s more to it than this, and I covered a lot of what I look for and how I exclude stocks when looking for trades in the LIVE session on Wednesday.
The main lesson you should take from this is how important it is to understand IV and follow your trading rules, especially during times when market volatility has become this inflated!
If you don’t have a set of rules, check out Operation Surge Strike because we have some awesome new setups coming in the next two weeks and you will want to be a part of that!
Remember the Rivian Automotive (RIVN) trade I was talking about for weeks?
We closed that trade out profitably within 24 hours, and there’s another one coming up SOON!
I’ll be sending out more information about that on Monday, so keep an eye on your inbox!
See you Monday for our next Power Profit Trades LIVE session at 11:30 a.m. ET!
Tom Gentile
America’s #1 Pattern Trader
