On today’s show:
- Buyers are PAYING MORE for options than they’ve ever paid… and sellers and MAKING more than they’ve ever MADE!
- What factors make up the premium price of a stock option?
- BONUS: Two companies that can pass on inflationary costs to consumers without pushback
- PLUS: Don’t miss out this week’s FREE options play – complete with strike price and expiration!
👉👉 IMPORTANT: Due to a technical error, we do not have a recording for today’s episode, but see below for complete show notes.
Norman kicked off the episode by asking Jack:
Options premiums seem to be ballooning, even Even before the Fed announcement.
In many cases, options buyers have to go further out of the money to get the prices they want to pay. And options sellers are able to make more on options that have higher changes of expiring worthless.
Jack says the reason is volatility, which is also known as Beta. When volatility or Beta rises, options prices rise right along with it.
Two factors driving up the prices of options:
- mom and pop traders – options volume doubled from 2020 to 2021, and again doubled from 2021 to 2022. Now in 2023, it’s as high as its ever been.
- you also have hedge funds and institutions who are hesitant to own a stock, but also afraid of missing out on a rally. So instead of buying a stock, they are buying options.
Norman told us that there seems to be a lot of excitement… with higher interest rates and returns on bonds, you’d thing excitement would cool, but it doesn’t seem to be putting a damper on options.
Jack told us that yes, people are buying TBills. Four week Tbills are over 5.3%. They have a higher yield than the 1 year, which is an inverted yield curve.
Jack owns more Tbills than ever before. That’s considered the “Risk free rate of money.” You can set them up to automatically invest in the next 4 week bill when the first one expires. Many investors would rather get 5% with no risk than getting into the market with risk.
But even so, options volume and premium has never been higher.
Here’s how you know they are higher: look at a call option 30-40 days out, about 10% over the market price of the stock.
Divide the price of that option by the price of the stock. if it’s over 1% – 1.5% it’s a steep premium. This is good for sellers, but bad for buyers.
Jack told us that the biggest factors influencing the price of an option are:
- the underlying stock itself – the current price and the volatility
- in the last week of options expiration, time decay eats away at the price of that option more than anything else
Example:
Let’s say you sell an option for $1 on Monday, it goes down every single day until it expires worthless on Friday. Great for sellers, terrible for buyers.
Norman asked Jack, “When you write a covered call, do you go out a little further knowing it’s safer? Or do you go with the fatter premium closer to the strike price?”
Jack told us that he has 2 strategies:
With a covered call, he goes a little closer to the stock price, about 7-10% higher than his cost basis or the market price with an expiration 30-40 days out. That lets him do it up to 12 times per year.
When he’s selling naked puts, he will go a bit further out of the money if he’d rather not have it put to him. But not too far, he still wants to get a good premium for his money.
The conversation then turned to how some traders don’t give enough thought to being tied up in a trade. Sometimes it’s better to exit and move on to something else that is working. Those frustrations get people off their trading plans. It exhausts them and makes them deviate from their plan.
Jack then told us the essence of why he prefers income trading over anything else:
When you can let time do all the heavy lifting, it’s the greatest thing. As a seller, you sell something that has value and when time passes, it expires worthless. There’s nothing else in business that has value today and has $0 value in a week (maybe vegetables or flowers).
This week we had a crazy week. Jack hardly ever recommends that people buy options, but one opportunity this week blew my mind.
The volume in options tells a story. Especially when you have a large buyer exhibiting “unusual options activity.”
The opportunity that caught Jack’s attention was one particular strike price on the ARM IPO that had the most volume relative to other strike prices.
That option was a $55 Put.
And the reason was because when the IPO launched, as usual, the underwriters let the price run up as much as they can for 2 reasons:
- to get the company that is IPOing the biggest possible investment
- because the underwriters get paid based off the amount of money the IPO brings in
So by letting the IPO price run up, people in the know understood that the price was going to come back down. When the stock jumped to above $65, people in the know started buying $55 Puts knowing the price would soon drop back down.
The best thing about the IPOs the fees will help Morgan Stanely, Goldman Sachs generate revenue.
Also, Jack hopes IPOs will come back, because that’s the sign of a bullish market.
Norman thinks higher interest rates could put a damper on IPOs.
In regards to the Fed, Jack said he doesn’t want Jerome Powell to stop raising rates. And the reason will surprise you:
The bulk of Jack’s time in the market in the 90s, the Fed was dropping rates. When they got to almost a 0% interest rate environment, it took away all the Fed’s power, because the only lever they have to pull is interest rates. And if they can’t go below 0%, then what?
So Jack actually WANTS the Fed to raise interest rates so that they will then have some leverage to lower them later.
Jack says that in the market environment we have right now, this eventual lowering of rates could set up the biggest bull run we’ve seen in our lifetimes.
The old advice of “Don’t fight the fed” hasn’t been true this year.
Norman added that the longer we go sideways, from a technical standpoint, the more we are to see an explosion upward in the market from the pent up demand. We’re still unwinding what Covid did to our way of life.
Jack says: “I’m bullish on America, on corporate America, on the American people.”
Jack & Norman’s 2 Stocks That Can Pass On Inflationary Costs To Consumers Without Problems:
- McDonald’s (MCD)
- Proctor & Gamble (PG)
Particularly McDonald’s, which has one of the best management teams in the world.
When other companies try to do that, consumers balk. But these 2 companies have no problem passing on higher costs to their customers.
Norman told us that McDonald’s has a huge base being one of the largest owners of real estate in the world.
Full disclosure: Jack owns both MCD and PG. McDonald’s has been in his family for nearly 30 years.
PG hasn’t performed well in terms of stock price, but it is a “dividend aristocrat”, so they are good for the dividends.
JACK’S PRO TIP: Never put a stop on an option, because everyone can see that and you’ll get stopped out. Especially if your stop price is within the trading range. Instead of a stop use a mental “out” and place the closing trade manually when you are ready to get out.
And finally, Jack’s free options pick for this week:
A rare recommendation from Jack to BUY an option (he’s usually all in on SELLING options)
This week Jack’s pick is to just buy straight call option:
BX (Blackstone) Sept 29 $111 Call
Pay $2.05 or even a penny more
Thanks and see you next week!
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— The Jack Carter Trading Team
