It's not your view about what way a stock is going to move that is so important - it's how you respond to that perception that is critical. Time and again I am asked what I think about the prospects of a security, but rarely do I ever get asked "what is the best way to apply a bullish view on a security?" As I have posted many times on SeekingAlpha, I am very bullish on large-cap US stocks. The main reasons: valuations and corporate health. In this article I want to highlight a way of expressing a bullish view, which I think few have considered, yet for many stocks, it is probably the best way to respond.
The price of many large-cap stock options has reached multi-month lows. Take Kraft (KFT) as a case in point. The implied volatility (the principle component of the price of an option) of 12months to expiry ATM options is the lowest it has been since 2004 (that is as far back as my records go but given the high volatile environment that existed since 2000 one could make a reasonable assumption that implied volatility is the lowest it has been in over 10 years.
Implied Volatility of ATM 12 Months to Expiry Options on KFT
Now you may ask what is the significance of all this? Well if you were to buy an ATM January 2013 expiry call on KFT (the 35 strike) it will cost $2.73. KFT would have to close above $37.73 at expiry for you to make money. This equates to an 8% move in 19 months. This isn't exactly a demanding move by any stretch of the imagination!
The principle cause of traders/investors losing money is that they allow losing trades to get away from them. By default, all that it takes to become a successful trader/investor is to let winners get away from you. I can think of no better way of positioning yourself to get lucky right now than putting a few hundred dollars into long dated call options on large-cap US stocks with very cheap options, Johnson & Johnson (NYSE:JNJ), Abbott Labs (NYSE:ABT), Wal-Mart (NYSE:WMT), Merck (NYSE:MRK), AT&T (NYSE:T), and Verizon (NYSE:VZ) are a few more examples that come to mind. The hardest part will be in resisting the temptation to take profits and ride these options to expiry, i.e. allowing yourself to get lucky!