Every once in a while, the market gods bestow a gift upon us “lowly” income traders…
… a stock with such insane volatility that collecting premium is like shooting fish in a barrel.
A stock that is so volatile that we can sell way, way out-of-the-money options over and over again, generating huge premiums for relatively little risk.
I received such a gift in the form of a little-known biotech company called Sarepta Therapeutics (NASDAQ:SRPT).
Sarepta specializes in developing RNA-targeted therapeutics for the treatment of rare, infectious diseases.
What does that mean exactly?
Damned if I know, but the stock’s implied volatility was off the chart.
The reason for the elevated IV in Sarepta had to do with the delay of a FDA decision on a controversial drug known as Exondys 51 for a rare and fatal genetic disorder called Duchenne muscular dystrophy.
Now I could’ve sold put options on SRPT or bought shares and sold covered calls to take advantage of the mouthwatering premiums.
But that would’ve tied up a lot of capital. Plus, it would have opened me up to a good deal of risk, especially since I had no idea when or which way the FDA would rule on the drug when it issued its final decision.
Instead, I like to sell volatility using credit spreads… less capital at risk…less pressure to be right… and the market was practically giving you free premium which the trading that was going on in the stock because of the delays.
On April 20th, I placed the first of what would end up being 17 straight winning spread trades in Sarepta.
With the stock trading around $19.50, I entered a 25/25.5 bear call spread on a Wednesday that expired that Friday for a net credit of $0.20 ($20 per spread). My margin on the trade was $0.30 ($0.50 width of the spread minus $0.20 credit).
While this spread had a bearish bias, it had nothing to do with how I felt about the stock or whether I thought the FDA would approve Exondys 51. I didn’t need Sarepta’s stock price to plummet in order to be profitable.
In fact, I didn’t need the stock price to go anywhere, which is one of the biggest advantages of trading credit spreads.
I trade out-of-the-money options with my credit spreads because they put the odds in my favor from the get-go.
In this case, I just needed SRPT, which was trading around $19.50, to stay below $25. In other words, as long as the stock didn’t rally more than 28% in two days, I was in the clear.
I traded 20 of the 25/25.5 spreads, generating $400 in income ($20 income per spread times 20 spreads) and had just $600 at risk ($30 margin times 20 spreads).
And sure enough, when the options expired worthless two days later, I retained my full credit, booking a 67% return.
That’s impressive in and of itself, but I was just getting started.
This is the fastest way to generate cash since the ATM was invented (seriously).
I continued to take advantage of the uncertainty surrounding Sarepta over the next few months as the FDA pushed its review date and requested more data.
Investors responded to these developments by piling into and out of the stock and keeping implied volatility in the options through the roof.
Some of the spreads I put on over the next few months were so far out of the money it was almost laughable. And I just kept ringing the register — on the bull and bear side.
For instance, in mid-May, SRPT was trading at $16.80, and I entered a 6/4 bull put spread with 14 days to expiration. That’s right, with the stock above $16, I sold a $6 strike put, meaning shares had to plunge more than 64% for my spread to be in trouble. Oh, and did I mention I was able to nab a $0.35 net credit for a 2-point spread that was that far out of the money?
A few trades later, I earned a $0.75 credit selling a 10/6 put spread with the stock trading at $23.85. It was almost too good to be true.
I ended up trading an additional 16 profitable credit spreads in Sarepta, both bullish and bearish, over the next four months.
Many of these spreads were way, way out of the money, providing me a big cushion if the stock moved against me, while the higher implied volatility supplied me with rich premiums.
In total, I generated $9,960 from the stock between April and August never risking more than $2,000 at any one time.
These amazing results from trading Sarepta were not due to my brilliant analysis or deep research on the stock. I’m a numbers guy, not a stock guy.
And the same remains true. The typical stock analyst or investment guru would’ve had you stay clear of Sarepta…from a fundamental long-term investment it was a terrible stock.
But this stock was perfect for my “simple math” approach where I trade around the volatility for bigger premiums and a richer pay-day.
I’m constantly on the lookout for more stocks like Sarepta that practically scream “take our money” time and time again.
And while I wait, the real beauty of trading credit spreads for income is that you mimic a casino manager who lays off bets in both directions once a week. Then you take the easy money in the middle for yourself.
About The Author
Meet Jon Lewis, With over 20 years of real experience, teaching AND trading, Jon will help you learn to use options profitably and safely in portfolios of any size.
His advantage, and now yours, is using simple, often overlooked spread options strategies which generate consistent income without significant risk.