Finding Value With Options Trading
Finding Value With Options Trading
There are many different reasons to invest in stocks. For example, some buyers are looking for growth, others income. Ultimately everyone is looking to make money… but how we get there is clearly open to interpretation.
One popular method of investing is value investing. That is, when investors look for an undervalued stock to purchase which is expected to gain relative to other stocks. Of course, there are many reasons a stock may become undervalued. So, investors need to determine which undervalued companies are likely to regain value in the not-too-distant future.
The biggest advantage of value investing is it has years of statistical backing in its favor. Over the last 100 years or so, buying undervalued stocks has pretty consistently led to better gains than a standard index buy and hold strategy.
So where does options trading come in?
Let’s look at an example.
Here’s the chart of $MOS:
Mosaic $MOS is a perfect example of a value stock. The fertilizer giant is an $11 billion company with over $1 billion in profits for year. Nevertheless, it’s trading at just 9.7x earnings… cheap by any comparison.
As you can see, MOS was trading relatively sideways for most of the year but then fell off a cliff during the August correction. While many stocks have regained lost ground since then, MOS has not, and remains near 52-week lows.
Whether you believe Mosaic is going to go back up soon or not, it’s hard to argue the stock doesn’t provide value at these levels.
So what are the benefits to using options?
As long as your time horizon is two years or less, there’s really no reason to ignore options when value investing. Like most other scenarios, options provide leverage and flexibility you can’t get with standard stock buying.
For instance, buying value stocks is a great opportunity to use bullish call spreads.
As a reminder, a bull call spread is a type of debit spread. In this case, you’re buying a call and simultaneously selling an OTM call against it in the same expiration. Because it costs money, it’s a debit spread.
While long call spreads cost money, they cost less than buying an outright call. This lowers your risk, while still giving you the potential to earn outsized returns.
Call spreads work well with value investing because there tends to be a defined exit point. That is, you believe your undervalued stock has a point it needs to reach to regain a more reasonable value.
For $MOS for instance, you can see that the stock isn’t likely to climb above the $44-$46 range it was trading in for most of the year. That gives us a very easy upper end to a potential call spread.
Since you have a ceiling on your value stock, you aren’t likely giving up potential returns by selling the upper strike. That’s the level you would have sold your stock/call at regardless. As such, it makes perfect sense to lower you call trade cost by using a spread.
In other words, you’re getting even more value out of your value investing by using options.
Yours in Profit,
Gordon Lewis
Options Trading Research
Note: Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com. You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.
Category: Options Trading
