Recognize Value and Trade Wisely

Dear Reader,

The Fed is gearing up to raise interest rates once again next week, which is a sure sign inflation of an uphill battle.

Nobody likes heavy inflation because it simply reduces your household buying power – you’re getting less bang for your buck.

But there are ways to work inflationary conditions to your advantage, and to profit from other forms of inflation.

It’s natural to drop your head and chin when you feel the sting of high prices, but you can change your spending habits to combat it – which can help you immediately.

So, I want to show you how we can exploit high inflationary times like we’re in now, but more importantly how you can profit from other forms of inflation.

Let’s talk about ways to take advantage of high prices and also look at option inflation and deflation and how to use it as a tool to make money.

Ugly inflation – The kind that churns your stomach.

When you look at the chart below it may give you a sick feeling about our current economic situation, but we’ll open our eyes to ways of exploiting it.

The graph above represents 20 years of inflation levels.

The chart is a 12-month percentage change in the Consumer Price Index (CPI) and highlights over a decade of time when inflation was channeling and in what became a “normal” range for inflation – 2009 to 2020.

You can see during the 2008 Great Recession where inflation peaked above the previous years at over 5 percent, which seems like peanuts by comparison to today’s inflation rates.

Fine, but the real question is what can we do about it… and the answer is we can’t control inflation itself on an individual level.

So instead, there are actions we can take to navigate times of high inflation and use it to our advantage.

The natural steps to take when we experience high inflation is to curb spending, look for alternative incomes and find substitutions for higher priced items. Finding any way possible to stretch our dollars is one way of fighting it.

But, when inflation affects the volatility in the market, we can turn the tables to favor us.

Here’s what I mean…

Suppose you’ve got some personal or real property that can be sold, but it does not need replacing immediately. With patience, we can sell things at today’s high prices and then replace them down the road once inflation has subsided.

It’s simply the same idea as trading in reverse so to speak. Sell high and buy low.

Well, it’s possible to apply this same idea to the stock and option market.

Let’s talk a little about implied volatility and how to recognize when it’s inflated or deflated and how to take advantage of it.

From the CPI graph I shared above, it’s clear when prices are high (inflated) at times and low at other times (deflated).

Now let’s look at the graph below, which shows various levels of implied volatility (IV) in option prices.

The volatility graph above illustrates high and low points of implied volatility in options.

Option implied volatility is similar to economic inflation, there are times it’s high and other times when it’s low – which simply means there are times when we are paying too much for options (inflation) and other times when they’re priced at a much better value.

As mentioned earlier, there are ways we can use higher levels of inflation to our advantage, such as selling things we have and replacing them later after inflation has subsided.

We can also apply the same idea with options, which can be bought or sold according to what’s happening with inflation.

Essentially, when options are inflated, they can be sold on the initial transaction and then once the price in the underlying security drops, those options can be closed out for profit.

And one of the easiest ways to identify inflated options is by the Volatility Index (VIX).

At times, IV is high, and it creates opportunities to sell options at inflated prices and buy them back later for profit.

Although inflation is especially high in our current economic situation, the VIX is painting a different picture for option inflation at the moment.

If you look at the right side of the volatility graph above, you’ll notice option IV is about as low as it has been in over a year – this tells us that buying options in this market environment is favorable.

So, when we see opportunities to be an option buyer, we can feel confident we’re trading the right side of volatility – meaning we’re buying “inexpensive” options.

Whether the market is coping with high or low volatility levels, opportunities present themselves – we just need to keep an eye out for what those opportunities are.

The important thing is to not get completely frustrated when conditions seem unbearable, such as our current economic situation.

Instead, look for favorable ways to use it to your advantage. Now, the economic situation can take months and even years to iron itself out, but as you keep an eye on the inflation and deflation of option prices, opportunities can be handed to us even on a daily basis.

Let’s talk some more about taking advantage of opportunities more systematically. Be sure to tune in to my live sessions each Monday through Wednesday on Money Morning Live.

I’ll see you soon,

Tom Gentile
America’s #1 Pattern Trader

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