I know firsthand that the easiest way to begin the journey into option trading is to find a way to relate to it. Many people, even those who trade stocks regularly, consider the stock market itself a big mystery, an enigma, which is why I think it’s the best place to begin. What’s actually behind the symbols and numbers you see on the crawls at the bottom of the TV screen or in the columns of fine print you see in the newspaper?
As a woman who once thought of the stock market as an abstract and baffling concept, I found it helpful to think of the market as a living being. Instead of thinking of it as being comprised of mathematical equations, it’s made up of companies (including their stock and its products or services, employees and associates) that move around in groups. As a living entity, the market inhales, or expands, and exhales, or contracts, and at times it holds its breath.
Said another way:
- During times of expansion, the market increases in value, or “puts on weight.”
- During times of contraction, its value (weight) goes down, as if “losing weight.”
- When the market holds its breath, it maintains its value, or weight, and moves sideways.
As we have seen in past months, the market has been putting on additional “weight” on a daily basis and, just as it would be for an average person, this kind of gain is difficult to sustain. As we have seen this week, there is a weight limit for the market, where indicators show that it is time to step away from the table. Time will tell if this is a short term loss in weight (much like my New Year’s resolutions 🙂 ) or a confirmed trend to balance out the health of the market.
Is there an upside to a down-trending market? In the options world there is. Remember, that Put options allow you to benefit from price declines. Typically, these are shorter positions than a Call.
The current fluctuation in “weight” could provide option traders with some ripe opportunities as the bulls and bears debate whether it’s time for more dessert or for a diet.
This debate brings the separate concepts of price and value into play. Simply said, while buyers and sellers can come to an agreement on price, they do not always agree on value.
When it comes to stocks, a trade takes place when one buyer is eager to sell stock at the same time another buyer wants to make a purchase. Quite often, when a stock drops in price, a trader is anxious to get rid of the equity, while another trader sees the drop in price as an opportunity to purchase an undervalued stock at a bargain price.
Value versus price is subjective. One company’s stock price may trade at fourteen times its earnings and will be considered undervalued with room to grow. Another company’s stock may trade at six times its earnings and will be considered overpriced and at its peak.
There are other influences that illustrate this difference in evaluation. An analyst group (Oppenheimer & Co., for example) may upgrade a stock based on their expectation of future earnings for that company, and the next day the stock’s price will soar. Nothing has actually changed to bring about this increase in value, except an expectation, a belief that good things are apt to happen. If this hope is not realized, the stock will drop back to its actual worth, or even below that level for a time, until the next event. A company’s reported earnings may disappoint analysts and traders, but, if the company’s outlook for the coming quarter is encouraging, the stock may still rally into the next quarter. Value and price are separate concepts.
As the bulls and bears fight for control of the market this week and in the short term, this debate over what will amount to the long-term health of the market as an entity creates trading opportunities. In the options world, there are investors buying more bearish Puts than Calls, indicating more interest in market correction than in purchasing low-priced, high-value stocks while the market is ripe for it. Time will tell if the market will remain on its diet or give in and begin putting on weight once more.