How to Profit from Extreme Volatility

On a theoretical basis, everyone knows to buy when others are fearful, to be contrarian, to avoid panic. On a practical basis, [however,] hardly anyone has the discipline and courage to act. [Below I outline] three ways that the individual investor can profit from the current volatility. Words: 614

So says Jeff Miller (www.oldprof.typepad.com)  in edited excerpts from an article* which Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. 

Miller goes on to say:

Method One — Go Shopping

The most direct method for profit is to rely on fundamental analysis to determine value.  Market fluctuations are opportunities.  If the market is dominated by fear, so much the better!…

Who in the world is currently reading this article along with you? Click here to find out.

Joel Greenblatt, author of  The Little Book that (Still) Beats the Market [which I consider to be] the best book in the last five years, noted recently on CNBC that trailing free cash flows were in the best 5% of any time in history [and that] when this has happened in the past, the market has rallied by 15% in the next year and “value stocks” have rallied 30%…

Method Two — Sell Puts

The rules for selling puts (an option where you agree to buy the underlying stock at a set price during a set period of time) have changed, making put-selling more difficult for everyone, including the individual investor.  You really need to know what you are doing.

With that warning in mind — this is a strategy that can work.  Here are the rules:

• Pick a stock that you want to own based upon earnings, price, balance sheet, cash flow, and dividends.
• Pick a price where you would love to buy the stock.
• Sell a put at that price.  You will collect the premium.  If the stock trades below your price on expiration, you might get “assigned” on the stock — which means you will buy at the price you set.
• Prepare to be disappointed if the stock does not trade lower.  You will still collect the premium.

This is a great way to play high-volatility opportunities.

Method Three — Covered Calls

This is a great method to exploit volatility, but it starts with fundamental analysis:

1. Find an attractive stock — all of the value metrics described above.
2. Look for a support level, either via a chart or your favorite technical analyst.
3. Consider yield via dividends.
4. Find an out-of-the money call that you can sell.

At a minimum you collect dividends, stock appreciation, and the call premium. You have limited upside in a big rally.  If the stock sells off, you have some protection from the call sale and the dividend. This is the most conservative of the three approaches.

Conclusion

Most individual investors read the headline news and panic.  They do not see when to seize opportunity or the best methods for doing so. [Now you do!]

*http://oldprof.typepad.com/a_dash_of_insight/2011/09/how-to-profit-from-extreme-volatility.html

Related Articles:

1.  Investor Fear Gauge: What Everyone Should Know About VIX

VIX is the ticker symbol for the volatility index that the Chicago Board Options Exchange created to calculate the implied volatility of options on the S&P 500 index for the next 30 calendar days. The formal name of the VIX is the CBOE Volatility Index [and informally as the investor fear guage]. Below is some introductory material on the VIX offered up in a question and answer format: Words: 915

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