We wrote an article recently where we sold rich option premium to the downside to take advantage of high implied volatility in that respective company. Selling inflated volatility or fear, as we like to call it, is a core part of how we diversify our portfolio. In fact, we would go further and state that many asset classes are more correlated than ever at present due to central banks’ quantitative easing programs over the past decade or so. Stocks, commodities, and precious metals should all do well over the long term in a money-printing environment, but this is a problem for the investor seeking true diversification. This is why we like how selling option premium brings extra diversification to the table as our implied volatility trades mostly are set up to merely look for a volatility contraction. When we get this contraction, we merely buy back the put or call options for cheaper prices.
In the article cited above, this was exactly the purpose of the trade we put on. We were never “investing” in the company at hand for the long term. We merely saw opportunity or fear and embraced this fear where we were in and out in 6 days. This many times in trading is half the battle.
Another stock which we are currently lining up for a volatility play is OPKO Health (NASDAQ:OPK). Shares are up 20%+ today due to the announcement that the company would be carrying out COVID-19 tests of all teams in the National Football League. Earnings estimated were already improving, so this deal should only aid that tailwind trend of higher earnings. The current projection for fiscal 2020 is now -$0.23, and 2021 has now entered positive territory ($0.04). This has positive ramifications for our trading and investing strategies as we tend to favour firms which are profitable (positive forward earnings multiples).
If we go to the weekly chart, we can see that shares fell for almost 5 years straight before bottoming in April of this year. Since that April low, shares are up more than four-fold which could lead many to believe that the opportunity is gone here. What is significant here, though, in our opinion, is that because the downturn lasted 5 years, much of that previous resistance has now turned into support, as we outline on the chart.
The rally over the past week or so, where shares have climbed close to $2 per share, has spiked implied volatility to almost 190% in the August cycle. The options of OPK are very liquid, so this brings opportunity to the table here for us because OPK is a low-priced stock (approximately $6 a share).
Source: Interactive Brokers
With earnings coming up over the next couple of weeks, we expect to see implied volatility remain elevated until the bottom-line number is announced. Consensus is looking for -$0.08 in earnings and $223.13 million in revenue. As eluded to earlier, OPKO with its much higher number of upwardly earnings revisions will be looking to make further gains when earnings are announced in due course.
The reason why we are attracted to these types of stocks is because the downside is limited for our particular strategies due to the price of the shares. For example, if we put on an options strategy pre-earnings which had long deltas, we could roll short puts contracts out in time to reduce our cost basis in the trade. Heck, we could theoretically roll naked put options to achieve something close to the price of the recent April lows (which should hold) if price were to go against us over the next few months. Suffice it to say, liquid low-priced stocks bring opportunity for us as options traders because there is a finite risk when long deltas are being used on the respective trade.
Right now, the fundamentals of OPKO health are strong. We state this because of how the technicals have been performing. We believe that all known fundamentals (including the recent deal) are embedded in the price action on the technical chart. From a risk-management perspective, we would like the recent rally to halt somewhat before upcoming earnings. Let’s see what Q2 numbers bring.
Elevation Code’s blueprint is simple. To relentlessly be on the hunt for attractive setups through value plays, swing plays or volatility plays. Trading a wide range of strategies gives us massive diversification, which is key. We started with $100k. The portfolio will not stop until it reaches $1 million.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.