The Options Trades that Hedge Funds Use

Risk and Odds

Insurance and Volatility

Oatmeal and Hash

I think I’m in pretty good shape. I’m 37 years old and am 5’11” and weigh 170 pounds. I exercise by playing tennis, swimming or working out at the gym three to five times a week. On top of that, I eat a healthy diet and see my doctor once a year for a physical.

Why am I telling you this? I can promise you this is not an online dating profile. (I’m happily married!)

The reason I’m telling you this is because two of my friends-who are similar to me in age, body type, exercise and eating habits- recently had major heart attacks in the same week.

So what was my wife’s instant reaction? “You need to get a full cardiovascular examination right now! I don’t care about the cost … you are doing this! And we’re getting more life insurance!”

I understand her reaction in some ways. She has seen the suffering my friends’ wives have gone through and she’s scared for my health and the family.

However, I’m an options trader; I measure risk and odds all day. Therefore I look at this from a totally different angle.

First, the odds of a “healthy” 37-year-old having a heart attack are incredibly small. The odds of a second “healthy” 37-year-old in a very small social circle having a heart attack in the same week are off-the-charts low.

And so the odds of a third person in our social circle (me) subsequently having a heart attack are likely closer to winning the lottery AND getting struck by lightning in the same day.

In this case, my reaction is 180 degrees away from my wife’s.

In fact, I would take the opposite approach of my wife’s. The options trader in me would not be buying more life insurance or getting a costly heart examination. I would argue that the odds of me having a heart attack are the same as they were before my friends’ recent health issues. Or I could argue that the odds are actually even smaller, as my friends’ problems have made me even more vigilant with my exercise, eating and watching my important vital signs.

What Selling Volatility Means

As I often tell subscribers to Cabot Options Trader and Cabot Options Trader Pro, selling insurance is a lot like selling market volatility. The seller of insurance hopes to price the risk of insuring correctly and every month collect a premium. In the same way, sellers of market volatility sell options and collect a premium. Option traders can sell a call, which would be a “bet” against stock’s or index’s upside, or sell puts, which would be a “bet” against a stock’s or index’s downside.

Here’s an example:

If you hear reports of a possible hurricane coming in the direction of your house, you’d likely be willing to pay a high premium to have as much insurance as possible in case of mass destruction. Thus the insurer would receive a higher than normal premium.

Likewise, when there’s fear in the market, traders aggressively buy market volatility in the form of puts. This fear allows the seller of volatility to raise the price to a point at which they are comfortable taking the risk.

Selling volatility has been a staple of my trading career. If priced properly, selling volatility can return steady profits.

Selling volatility has become a very popular strategy for institutional investors in recent years. Pimco’s “Bond King” and founder Bill Gross recently disclosed at a conference that the firm has been a seller of market volatility for some time. “Sounds dangerous and [it] is sometimes,” Mr. Gross said. “Obviously, the volatility has to be underwritten properly and priced appropriately. It doesn’t pay to write flood insurance before a flood, but over time, it has been a very respectable structural template alpha generator.”

There are many ways to sell market volatility on both individual stocks and the major indexes.

If a trader had a bullish or neutral view on the market, yet wanted to sell volatility, he could:

* Execute a Buy-Write/Covered Call
* Sell Naked Puts
* Sell Bull Put Spreads
* Execute an Iron Condor

At Cabot Options Trader and Cabot Options Trader Pro, I write educational pieces that build on these and many other options topics and strategies. And I’ve amassed a significant number of educational pieces on these strategies, which subscribers can reference at any time on the Cabot Options Trader website.

With Cabot Options Trader and Cabot Options Trader Pro advice and education, my subscribers are able to put on volatility-selling trades that are similar to the trades of Bill Gross and many of the top hedge funds in the world.

Get more information on Cabot Options Trader here.
We’re opening its limited membership to Cabot Wealth Advisory readers today. So if you missed our previous double-digit winners or missed joining the beta test last week (my beta testers received a quick 20% gain on one of our trades in less than 24 hours!), now is the time to claim your spot. Learn more here.

One last note: Despite my case for not worrying about my heart attack risk, I did cave in to my wife’s demands-I’m now eating a lot more oatmeal for breakfast and a lot less corned beef hash.

Your guide to successful options trading,

Jacob Mintz
Chief Analyst
Cabot Options Trader and Cabot Options Trader Pro


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