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A Volatile Day in the Stock Market for Options Traders

Yesterday was another extremely volatile day in the markets. At the lows of the day, the S&P 500 traded lower by approximately 2.5%. In the afternoon, the stock market was able to stabilize and close the day lower by just over 1%.

The intense selling pressure on the market leaders such as Facebook (FB), Google (GOOG) and Microsoft (MSFT)continued yesterday. For example, from the highs of last Tuesday at 117.50, FB has fallen to a low this morning of 96.82.

Trying to call a bottom in this environment is impossible. While you and I may think FB is a great value at 100, one might have thought the same about Netflix (NFLX), Amazon (AMZN) or Tesla (TSLA) at some point this year. However, these stocks keep making new lows nearly every day. For example, TSLA is down nearly $100 since the start of the year (I will release my big TSLA earnings email tomorrow morning).

Similarly, the list of stocks that have dropped extremely fast since Friday is full of stocks that traders loved just weeks before. For example, since last Thursday, (CRM) has fallen from 67 to a low of 52.50 yesterday. Similarly, Adobe (ADBE) has fallen from 88 to 71. Traders have used the terms valuation reset, or bear market, to describe this extreme price action.

This extreme selling pressure picked up steam last Thursday after LinkedIn (LNKD) and Tableau Software (DATA)reported earnings. Both stocks fell approximately 45%. I want to continue to stress the old trading rule about stock disasters such as these … wait at least three days before even thinking about getting involved in a bullish position. The thinking behind this rule is that it takes large institutions at least three days to sell out of their big positions. If you follow such a rule, tomorrow would be the first day that you could even consider getting long those stocks.

As I have mentioned many times in the last several weeks, the financials continue to send very concerning signals. Deutsche Bank (DB) and the other large European banks are what traders are most focused on. However, financial stocks in the U.S. such as Bank of America (BAC), Morgan Stanley (MS) and Goldman Sachs (GS) are making multi-year lows as well.

Much like the technology stocks mentioned above, picking a bottom in these bank stocks is likely impossible. However, if you’re looking for a long-term bullish trade, buying calls that expire in January of 2017 is likely the best way to get long, without being too concerned about daily price fluctuations. An example is BAC January 13 Calls (exp. 1/2017).

As I’ve mentioned in the past, executing bullish positions in stocks that have beat earnings expectations and gapped higher, is one of my favorite strategies. And I keep a running list of those stocks. Yet time after time in the last week, those earnings gaps have faded. Stocks that had been on my list but have since fell apart include:

Paypal (PYPL)

Facebook (FB)

Vantiv (VNTV)

Abiomed (ABMD)

Nevro (NVRO)

While those stocks are still prime candidates for new positions, as earnings winners tend to lead in most markets, I’ll need to see a couple of days of strength in the market or those stocks before getting involved.

Order flow continues to be very mixed in recent days/weeks. I have yet to see the big traders taking a big bullish stand amid the carnage, or conversely, making massive bearish bets. While the VIX is certainly on the higher end of the spectrum, it’s hardly screaming panic, even as the talking heads on TV do so. I continue to be in a wait-and-see mode, though clearly the price action in former market leaders and banks in the last several days and weeks is extremely concerning.

Being patient is challenging for many traders, and especially options traders. We’re often looking for the next home run. However, in this environment, patience is key. Trying to buy the low or chase the sector that is attracting new money is a great way to get hurt. As I have said, the sector rotation and daily price swings have been breathtaking. Blink, and you are in the right sector. Blink again, and you are back in the wrong sector. Because of this, I continue to stress that if you are adding new bullish or bearish positions to keep your capital allocation to each trade small.

Jacob Mintz is a professional options trader and editor of Cabot Options Trader. Using his proprietary options scans, Jacob creates and manages positions in equities based on unusual option activity and risk/reward.