Our market hasn’t had the best year. In 2016, the ASX 200 climbed nearly 7%. But in 2017, we’ve gone nowhere. Year-to-date, the ASX 200 is basically flat, as shown below.
Source: Google Finance
While there have been a few standout winners and losers in the top 200 stocks, around 40 stocks are in a range between -3% and 3% for the year.
So what can you do to profit from a stock trending sideways? One way is to use options.
Say you wanted exposure to Stock A. You expect the stock will trend sideways in the near future. But you’re also aware that if political tensions continue to rise, it could cause the Stock A to fall.
In such a scenario, buying Stock A isn’t the best idea. You’re not expecting the stock to appreciate, and you’re taking on downside risk if political tensions pick up. You likely wouldn’t want to sell short the same stock either. Your capital would be tied up in a position based on a hunch that may or may not pay off.
You could always forget about the stock and move onto the next opportunity. But let’s say you really want that exposure.
Well, in this case you could sell what’s called a straddle — that is, simultaneously selling a put and a call option with the same strike price and expiration date.
Both options would be out-of-the money. Meaning the strike price of the put option would be lower than the current price of the stock, and the strike price of the call option would be higher than the current price of the stock.
If the current price of Stock A continues to trend sideways, both the put and call options would not be exercised, and you’d collect a premium from both. You would profit from the stock doing nothing.
Of course, with such a position, you are at risk of the price rising or falling. For example, if the stock fell significantly, then your put option would be exercised and you’d be on the hook to pay out the difference. Similarly, if the stock appreciated significantly, your call option would be exercised and you’d again be on the hook to pay the difference.
Selling a straddled stock has a limited upside and a potentially unlimited downside. However, if you’re confident a stock, or the market, will trend sideways, it is one way to profit.
Junior Analyst, Money Morning
PS: Dividends are another great way to grow your income, even if the market trends sideways. Check out the top five dividend stocks on the ASX for 2017 right here.