Here’s Your Next Profitable “Fear Trade”

Oil Makes the World Go Round [Morning Reckoning] October 08, 2024 [WEBSITE]( | [UNSUBSCRIBE]( Here’s Your Next Profitable “Fear Trade” Baltimore, Maryland October 08, 2024 [Greg Guenthner] GREG GUENTHNER Good Morning Reader, Hurricane Milton is slicing across the Gulf of Mexico, intensifying into a monstrous Category 5 storm that’s now threatening to lay waste to Florida. If you’re keeping score at home, this will be the second major storm to make landfall in the US in a matter of weeks. Tampa residents haven’t even finished clearing debris from Helene – and now many are forced to evacuate ahead of Milton’s landfall. Unfortunately, this potentially disastrous weather event isn’t the only October surprise we’re encountering this week… Hezbollah showered Haifa in rocket fire early Monday morning. Meanwhile, Israel expanded its operations in southern Lebanon. Every day brings new escalation in the Middle East as the world watches to see just how far the conflict will extend. The news cycle is getting a little scarier these days, even with the major averages perched within spitting distance of all-time highs. But I still think there’s a decent chance that some additional fear could weigh on stocks over the next several weeks. So, what’s the ideal fear trade that’s ready to blast higher over the next few weeks? [MASSIVE New AI Prediction Just Issued]( [Click here to learn more]( Elon Musk will take the stage at Telsa’s investor event on October 10, where he is expected to reveal his biggest plans for Tesla’s future. We believe that one tiny AI stock will not only be absolutely critical to these plans but could also be the most important AI stock to the future of the markets AND your personal wealth. [Go here to learn how to get the ticker details ASAP.]( [LEARN MORE]( Energy Stocks: Worst to First The world runs on oil and gas. Refined oil products – paraffin oil, white mineral oil, petroleum oil, and other petrochemicals – are found in everyday household products from aspirin to cosmetics. Fertilizers, plastics, rubber, poly–blend workout gear with SPF protection… even your couch cushions are made with polyurethane foam. Even so-called green tech is completely dependent on the sector. Tesla can’t make a single Robotaxi without crude oil. How do you think they would pull all the copper out of the ground? But lately, the market hasn’t acted like this sector matters much at all… If you were searching for gains this past summer, you weren’t finding them in energy stocks. In fact, energy stocks came in dead last amongst the major sectors in Q3 performance, with the Energy Select Sector ETF (XLE) dropping more than 3% July through September. The sector was even threatening to flip negative on the year just a few weeks ago as many of these stocks continued to unwind from their April highs. The situation changed just before the calendar flipped to October. XLE has rocketed higher by nearly 10%, closing higher for seven straight trading sessions to reach levels not seen since late May. Of course, the situation in the Middle East is aiding the dramatic rise in oil and energy names. Goldman Sachs is now warning Brent crude could see $90-plus if Iranian oil comes off the market. Turning to light crude, we can clearly see the shelf of support going all the way back to early 2023. Buyers have stepped up every time light crude has retreated to the mid-$60 range. And thanks to the fear factor, it has enjoyed a 15% bounce off those lows. This is an impressive first thrust off the September lows. And it’s just getting started. With the herd just beginning to pile into forgotten energy names, we could see this rally continue – with no shortage of explosive trading options. If You Want Energy, You Have to Go Out and Buy It… Energy stocks currently account for a little more than 3% of the S&P 500. The sector’s weighting increased to 15% during past oil spikes over the past several decades – and the average weighting is roughly 10%. We’re obviously nowhere near these levels right now. If you want oil, you have to get after it. You simply cannot buy an index fund and expect to capture any returns from the energy sector, especially since many of the most prolific “dirty” energy names have been purged from the indexes. Case in point: XOM. The Dow booted Exxon Mobil in 2020 shortly after oil futures went negative in the midst of the pandemic crash. At the time, XOM was trading near 15 year lows. Not anymore! XOM is casually hitting new all-time highs this week. The stock has now climbed more than 300% off its 2020 lows. It also doubled its Permian Basin holdings after acquiring Pioneer Natural Resources for $60 billion last fall. As more investors notice ExxonMobil’s sly breakout, money will flow upstream to the exploration and production industry. These are the companies pulling the raw material from the earth: Transocean (RIG), Occidental Petroleum (OXY), Diamondback (FANG), and Marathon Oil Corp. (MRO). There are already explosive rallies underway in these names. Volume is increasing and we’re seeing renewed near-term relative strength amongst the E&Ps. I like buying strength in this group, as well as grabbing last cycle’s leaders against logical support levels. Marathon Petroleum (MPC), Phillips 66 (PSX), and Valero (VLO) all hit new all-time highs earlier this spring. We could also see additional mergers and acquisitions in the sector since ESG makes it more attractive for the majors to acquire, rather than develop acreage. The FTC recently approved Chevron’s acquisition of Hess. Diamondback Energy closed its merger with Endeavour Energy Resources last month. Even Midstreams are merging, with Oneok acquiring Magellan Midstream Partners last fall. A Stickier Rally We haven’t spilled a ton of ink over the energy sector since the very start of the second quarter. Yes, it was a strong contender for a summer rotation play when crude retook $80 and the big oil and gas companies posted market-leading moves in late June. But the sector was unable to rekindle the magic from that huge breakout move way back in April. You probably recall how XLE rallied double-digits, only to run into trouble and fizzle out. It’s different this time around. Once money starts pouring in – combined with a little bit of the fear we’ve been talking about – we’ll know we’re in the thick of a strong energy bull. Best, [Greg Guenthner] Greg Guenthner Contributing Editor, Morning Reckoning feedback@dailyreckoning.com [Send Me Your Mailing Address!]( [Click here to learn more]( What I’m holding in my hands is the “most dangerous book” in America right now. It paints a grim picture of our country’s future just a few years from now…in 2029. But I’m offering to send you a copy for free today as a way to help prepare you for what could happen next. [Click here now to see how to claim your copy.]( [LEARN MORE]( In Case You Missed It… Straddles and Strangles Sean Ring, Editor [Sean Ring] SEAN RING Dear Reader, In times of uncertainty or market turbulence, investors often look for ways to profit from volatility, rather than trying to predict the direction a stock will move. For traders, the concept of volatility itself becomes the most attractive asset to exploit. Two popular strategies for capitalizing on price swings are long and short straddles and long and short strangles. These strategies are designed to profit from volatility, whether the stock price moves up or down. This offers a unique, if expensive, advantage in uncertain markets. In this piece, we’ll examine the mechanics of these volatility trades — long and short straddles and long and short strangles — detailing how they work, when to use them, and their associated risks. Understanding Volatility in the Options Market Before we delve into the specifics, let’s set the stage with a quick primer on volatility. Volatility is the heartbeat of the market, measuring how much a stock price is expected to fluctuate over a given period. Implied volatility, derived from the prices of options, reflects market expectations about future volatility. When volatility is low, stock prices tend to move in narrower ranges. When volatility is high, price swings tend to be larger. Options traders may take advantage of either scenario using strategies that exploit significant movements (or lack thereof) in the underlying asset’s price. The Basics of Straddles and Strangles Both straddles and strangles are types of non-directional options strategies. The goal here is not to predict whether a stock’s price will go up or down, but simply that it will move—hopefully, significantly. Let’s simplify them. What’s a Straddle? A straddle involves purchasing or selling both a call option and a put option with the same strike price and expiration date on the same underlying asset. - Long Straddle: The trader buys both a call and a put option at the same strike price. This strategy profits if the stock moves significantly in either direction, rising sharply or falling significantly. This is known as “buying volatility.” - Short Straddle: The trader sells both a call and a put option at the same strike price. This strategy profits when the stock price stays relatively stable, as the trader collects the premium from both options. This is known as “selling volatility.” What is a Strangle? A strangle is similar to a straddle but with one key difference: the trader buys or sells a call and a put option with different strike prices. The call option is typically purchased at a higher strike price than the current stock price, while the put option is purchased at a lower strike price. - Long Strangle: The trader buys both a call and a put with different strike prices, betting that the stock will make a significant move in either direction. This strategy is typically cheaper than a long straddle because the options are further out of the money. Like a long straddle, this, too, is buying volatility. - Short Strangle: The trader sells both a call and a put with different strike prices, hoping the stock will not move much, and the options will expire worthless. The trader profits by pocketing the premiums from selling both options. Like a short straddle, this is also selling volatility. Now that we’ve outlined the basic structure of straddles and strangles, let’s explore the scenarios in which each strategy should be employed. The Long Straddle: Betting on Big Movements How it Works: A long straddle involves purchasing both a call and a put option at the same strike price. For example, if NVDA is trading at $100, you might buy a call option with a strike price of $100 and a put option with the same strike. Your goal is to profit from a sharp move in either direction. If NVDA skyrockets to $130, your call option will rise significantly, potentially leading to substantial profits. Conversely, if NVDA plunges to $70, your put option will be highly profitable. But remember, you paid premiums on both the call and the put, so this strategy isn’t cheap. This strategy works well when you expect increased volatility but don’t want to bet on the direction of the price movement. When to Use It: Long straddles are ideal when you expect a stock to experience significant volatility but aren’t sure whether the stock price will rise or fall. This could be ahead of a major earnings report, the announcement of new regulations, or significant geopolitical events—any situation where a company or the broader market may see increased price movement. Being aware of these events gives you a strategic advantage. Risks: The main risk with a long straddle is if the stock price doesn’t move much. Both the call and put option could lose value, leading to a loss equal to the combined cost (premium) of buying both options. For the strategy to be profitable, the stock price must move enough to cover the premiums paid for both options. The Short Straddle: Profiting from Stability How it Works: A short straddle is the opposite of a long straddle. In this case, you sell both a call and a put option at the same strike price. You’re betting that the stock won’t move significantly, allowing both options to expire worthless. You keep the premium collected from selling the options. For instance, if you sell a $100 call and a $100 put on NVDA, and NVDA stays close to $100, you’ll collect — and keep — both premiums as profit. When to Use It: This strategy is ideal in low-volatility environments or when you believe the market is overestimating how much a stock will move. You’re essentially taking advantage of the market’s expectation of volatility and profiting from stability. In the world of fixed income, for years, traders sold straddles on the Fed Funds rate because they knew the Fed wouldn’t budge. They made millions off it. Risks: The risk with short straddles is unlimited. If the stock price moves dramatically — either up or down — your losses could be substantial. If the stock skyrockets, the call option you sold will lose value; if it tanks, the put option will lose value. Given this risk, short straddles are typically employed by advanced traders who have strong convictions about market stability. This strategy has a negative gamma. In plain English, you lose more than your model anticipates. This type of trade caused Nick Leeson to blow up Barings Bank in 1995. Beware. And be wary. The Long Strangle: A Cheaper Bet on Volatility How it Works: A long strangle is a variation of the long straddle but with a twist: you buy a call and a put with different strike prices. For example, with NVDA trading at $100, you might purchase a $110 call and a $90 put. You’re still betting on volatility, but this strategy tends to be cheaper because both options are out of the money. Profit potential arises if the stock significantly moves above $110 or below $90. The upside is unlimited, and the cost of entering the position is lower than a long straddle. When to Use It: A long strangle is a good strategy when you expect a big move but want to reduce your initial outlay compared to a long straddle. It’s a more budget-friendly way to play volatility, but it requires a larger move in the underlying stock to become profitable since both options start out of the money. Risks: Similar to the long straddle, the risk is that the stock doesn’t move significantly, and both options expire worthless. Because the options are out of the money, the stock needs to move more than it would in a straddle for the position to become profitable. The Short Strangle: Limited Volatility, Limited Profits How it Works: A short strangle involves selling a call and a put with different strike prices. For instance, you might sell a $110 call and a $90 put on NVDA if it’s trading at $100. As with the short straddle, you’re betting that the stock won’t move significantly, and you collect the premiums from selling both options. Because the options are further from the current stock price, this strategy has a wider profit range than a short straddle, though the premium collected is smaller. When to Use It: A short strangle is ideal in scenarios where you expect limited volatility but want a margin of safety. You’re still betting on stability but with less risk than a short straddle. It’s a common choice for traders in range-bound markets or when implied volatility is unusually high. Risks: Like the short straddle, a short strangle carries significant risk. If the stock moves significantly, you’ll incur losses on either the call or the put, depending on which direction it moves. However, because the strike prices are further apart, the potential for significant losses is reduced compared to a short straddle. Wrap Up [It’s incumbent upon me to tell you that I never sell options]( unless I’m closing a long options position. But I also want to show you the markets, and these trades play an important part. Many traders sell options profitably… until they don’t. However, volatility trading provides a versatile approach to navigating uncertain markets through strategies like long and short straddles and strangles. Whether you're looking to profit from sharp price movements or betting on calm, range-bound trading, these strategies offer a way to trade on volatility without needing to predict the direction of price changes. But they also come with unique risks. Long strategies require enough movement to cover the cost of premiums, while short strategies expose you to potentially unlimited losses. Knowing when to use each strategy — and carefully managing your risk — helps turn uncertainty into opportunity. As always, these options strategies require a solid understanding of the risks involved and a well-timed approach. Stay sharp and watch the markets carefully — because in volatility, the only certainty is uncertainty. Good hunting! [Sean Ring] Sean Ring Contributing Editor, The Morning Reckoning feedback@dailyreckoning.com X (formerly Twitter): [@seaniechaos]( Thank you for reading The Morning Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [Greg Guenthner] [Greg Guenthner, CMT,]( is chief strategist at Forge Research Group. He has spent the better part of the past two decades developing long-term and short-term strategies with a single goal in mind: to help everyday investors generate outstanding returns and control their financial futures. Greg’s charts, analysis, and insights have appeared in Marketwatch, Forbes, Yahoo Finance, and many other financial publications. [Paradigm]( ☰ ⊗ [UPDATE PREFERENCES]( [Contact Us]( © 2024 Paradigm Press, LLC. 1001 Cathedral Street, Baltimore, MD 21201. By submitting your email address, you consent to Paradigm Press, LLC. delivering daily email issues and advertisements. 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