[Editor’s note: Over the past six months, options guru Jeff Clark has made more money for his S&A Short Report readers than any other editor at his investment research firm. And he’s doing it by trading one of the most popular sectors in the market today: precious metals. Below, Jeff explains why he believes these stocks could offer the best risk/reward setup right now, how he finds winning trades, and his expectations for future volatility.]

Sean Goldsmith: Jeff, I know you don’t like to brag, but your track record this year has been stellar. Since June, nearly 80% of your picks have been winners, with an average return of nearly 30% per trade. What’s your secret?

Jeff Clark: This is an emotionally charged stock market. Stocks are moving from one extreme to another. We go from overbought to oversold, back to overbought, and then oversold again within just a few days. The best trades this year have come from waiting to hit those extreme levels – when everyone is either panicking to get out or panicking to get in – and then betting on a reversal.

SG: Why have you been focusing on precious metals lately?

JC: They’re the most emotionally charged stocks. Maybe that’s because many gold investors are hedging against the end of the world. So they’re a little uptight to begin with. When we see a lot of volatility in the stock market, the gold sector seems to magnify that condition. It creates a lot of extreme conditions, which leads to a lot of opportunities.

[ad#Google Adsense 336×280-IA]SG: In a general sense, could you describe your trading strategies? What are some of the indicators you look for to make sure you’re timing the trade correctly?

JC: I follow several dozen technical indicators. They shift in and out of favor all the time. So I’m constantly adjusting my focus to find the indicators that track the market best under current conditions. What works today may not work tomorrow. So you have to be careful not to get locked in on any one strategy.

Having said that, one indicator that is working well at pointing to extreme conditions that may lead to a reversal in the overall stock market is plotting the S&P 500 against its 10-day exponential moving average (EMA).

The 10-day EMA works like a magnet for the S&P over the short term. Whenever the index strays too far from its 10-day EMA, it reverses and trends back toward the line. We’ve seen a lot of 50-point spreads between the S&P and its 10-day EMA lately… and that has set up a lot of good contrarian trades.

It also helps to watch the action in some of the more “macro” type indicators, like copper or the U.S. dollar. There’s a fairly strong recent correlation between the action in stocks and the action in both copper and the dollar. Watching both of those will give you a good look at the bigger picture.

SG: Trading options isn’t for everyone. In your opinion, how should options be handled in a portfolio? And who should consider reading your service?

JC: Actually, I think trading options can be a good strategy for everyone – as long as you’re doing it the right way. Remember… options were originally designed as vehicles to reduce risk – to lessen your exposure to volatile moves. Over the years, though, they’ve morphed into speculative vehicles used to add leverage to a portfolio – to get more bang for the buck.

A lot of novice traders use options to gamble – which is just a stupid idea. You can’t make money gambling in the stock market.

Successful traders understand the concept of probability. In other words, we calculate the odds of a profit or loss on any given trade, and we only take those trades with the best chance of profiting relative to the risk we’re taking. Using options allows us to create a more favorable risk/reward setup.

SG: Many of our readers believe options are risky trading vehicles. But you often say trading options is safer than trading stocks. Why’s that?

JC: It’s actually quite easy to understand. Let’s say you like XYZ stock at $10 per share. You think it can rally to $15 over the next three months. And if you’re wrong, you’ll cut your loss if XYZ trades down to $8. So you’re willing to risk $2,000 for the opportunity to make 50%. That looks like a decent setup. But by using options, you can actually reduce your risk and increase your potential return.

Let’s say XYZ has call options available that allow you to buy the stock at $10 per share any time in the next three months. And the options cost $1 per share ($100 for each option that allows you to buy 100 shares). Instead of investing $10,000 to buy 1,000 shares of stock, you can buy 10 call options – which give you the right to buy 1,000 shares at $10 each – for $1,000.

If the stock goes up to $15 per share, the call options will be worth $5 per share, or $5,000. You put up $1,000, so you have a $4,000 profit – a gain of 400%.

If the stock goes down, the most you can lose is the amount you paid for the options – $1,000.

If you buy XYZ stock, you’re willing to risk $2,000 for the chance to make a 50% return on your money. By buying the options, however, you’re risking only $1,000 for the chance to make 400%.

This is the right way to use options. Here, you’re using the options to give you a chance to make a higher return, with less risk than buying the stock.

SG: I think we all agree volatility is going to increase. And you can profit from that by trading the Volatility Index (the “VIX”). Have you been watching this trade?

JC: Yes, I have. But let me point out… the fact that you said “we can all agree volatility is going to increase” tells me that is the popular opinion. So I’m tempted to bet on a decline in volatility in the short term.

You have to pay attention to volatility when trading options. It’s always best to buy options when volatility is low and the options are cheap. When volatility is high, the options get expensive, which reduces the probability of profiting on a trade.

That’s why, often, no matter how confident I am that a stock may move higher or lower, I’ll pass on a trade if it costs too much to get into the options.

SG: Finally, what other trading opportunities do you see in the future?

JC: The precious metals stocks seem to offer the best risk/reward setup at the moment. And I’ve been recommending option trades in that sector.

I’m also warming up to stocks in the natural resource sector, like oil and natural gas. We’re getting close to extremely oversold conditions there. So we may get some buy-side opportunities soon.

Keep in mind, though, things change quickly in this environment. Heck, I was bearish on the stock market recently when the S&P 500 was trading at 1,250. It only took two days and a sharp decline in the market to shift sentiment in the other direction.

I have to go back to what I said earlier… Don’t get locked into one particular idea or strategy. The best way to trade this market lately is to wait for stocks to hit extreme levels and then look for a move in the opposite direction.

SG: Thanks for your time, Jeff. And here’s to your continued success.

JC: Thank you.

Goldsmith note: If you enjoyed this interview, we encourage you to learn more about Jeff’s option-trading strategies and how he’s consistently made triple-digit returns over the past six months. His trading streak is one of the most incredible we’ve ever seen. You don’t want to miss this opportunity. Click here to get started.


Sean Goldsmith

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Source: The Growth Stock Wire