The stock market has been in turmoil for 6 weeks now. The Indexes are well off of their highs and some more than 20% lower. This can go on forever but history suggests probably not. In the meantime, while you wait for a bottom to form what is there for an investor to do? You can trade on the short side of the market. This is difficult for professionals though. You can put together a list of stocks you want to buy when that turn happens. Or if you are comfortable with options there is a grey area in between.
Options allow you to tailor a risk management strategy to the stocks in your portfolio. But they also allow you to in a sense, name your own price, where you want to buy a stock. One stock that I have liked for a while is Constellation Brands (N:STZ). This stock has had a great trend higher since mid 2012. That is until last week. Since then the stock has fallen from a high over 154 to a low Monday at 130. That is more than a 15% drop.
Is it time to buy this stock? Maybe. The chart shows a Hammer forming and if that is confirmed by a higher close Tuesday it would be a buy signal. But the broad market still feels weak and could overwhelm any stock, dragging it lower. You want it but not if it has not stopped falling. I did ‘buy’ it today, but with an options strategy.
One way to trade into this type of a stock is by using a 1×2 Put Spread. This is buying a Put at one strike and then selling 2 Puts at a lower strike. For Constellation Brands I chose a March 130/125 1×2 Put Spread, buying the March 130 Put and selling 2 of the March 125 Puts.
If the price ends up between 130 and 125 on March Expiry I make money on the 130 Strike Put. If it closes at 125 I make $5. And a close below 125 means I will be put the stock, but with a basis of 120. So this strategy gives downside participation and a price entry point at a lower level. Best of all this trade can be put on today for $1.10 credit. So it makes money anywhere above 118.80 on the March close, whether you get your stock or not.