3 ultimate risk-on option trades

Owning calls or puts could pay off on these issues, which are poised for huge moves.

By Traders Reserve Jun 3, 2013 5:54PM

Image: Dice on stock listings (© Kate Kunz/Corbis)by Jamie Dlugosch

The options market is the ultimate risk-on trade. Owning call or put options on a particular stock can generate massive returns in a very short period of time, with small amounts of capital risked.

While options can be used to generate yield or hedge an investment, they can also be used for pure speculation.

Get the direction of any stock move right and you can significantly augment your returns by owning call or put option contracts. Here are three ultimate risk-on option trades that have the potential for huge moves.

How does doubling your money or much more, in say a month or two, sound?

Generally speaking, it takes a stock moving anywhere from 5%-10% for an option contract to double in value. As you know, such moves are a regular occurrence in the market.

It’s fertile ground for risk-hunters. The only trick is to find the right opportunity.

One place to look is when a company reports quarterly earnings reports. These regularly scheduled news events are rife with wild stock swings -- that often result in option contracts gaining 100% or more.

Another way to target these big movers is to focus on high beta stocks. Beta is a measurement of volatility. A beta of more than 1 suggests a stock will move higher than the major indexes in an up market, and vice versa.

Whatever your preferred hunting ground may be, why not take some of your fun money and play the option game by owning calls or puts? A few hundred dollars is all it takes to generate an extra grand or two, each and every month.  Owning calls or puts could pay off on these issues:

Herbalife (HLF)

Short squeezes are a great way to find a stock with big move potential. If you believe the shorts have it wrong, why not buy a longer-dated call option and wait for the shorts to run for cover? When they do, you can make some big money.

I recently recommended subscribers of my Players Club trading service to do just that with respect to Herbalife. The nutritional supplement distributor has been accused of being a Ponzi scheme by influential hedge fund manager Bill Ackman. The long side quickly attracted many, including Carl Icahn, questioning the short theory. In its last earnings report, the company released very strong operating results that exceeded expectations. In the days after the report a small short squeeze occurred. The final coup de grace for Ackman is still to come. Buying a long-dated option could double your money or money in less than three months' time -- assuming the stock trades higher in that time. Why not place a bet here? It’s better than a lottery ticket.

Netflix (NFLX)

Talk about volatility. Netflix sure has that, and in spades too. Traders are placing their bets on this one in advance of the next earnings report. The last time out, the company blew away analyst estimates as its streaming business started to fly. Shares jumped to a peak of nearly $250 per share before falling back to current levels in the last two weeks.

Where do we go next?The next earnings report will tell us in a big way. Netflix recently made a big splash by releasing original programming. The stakes are high, as such content is designed to significantly increase the number of subscribers for the service. The model is sound, but there is big risk on the downside here. Any sort of negativity could result in the stock dropping hard. An August put option is the place to wager. You can cash your ticket after earnings are released.

AK Steel (AKS)

Here’s a fun way to play the ultimate risk-on option trading game: find a high beta stock that is currently out of favor. The idea is to take advantage of an eventual bounce-back. If the stock is low priced like AK Steel, the coil effect could be quite significant. It’s impossible to know exactly when that bounce comes, hence a longer-dated call option would be the play here.

The steel sector has been one of the worst performers in the current market. Governments and central banks across the globe are doing everything possible to re-inflate. Steel is an excellent re-inflation trade, and shares in the space are currently depressed. It won’t take much of a move for AK Steel to jump another 50 cents. Consider placing a bet on September calls.

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