When thinking about how to handle stock market corrections, we tend to think about raising cash. But options can be a useful tool in corrections as well, according to Joe Mazzola, head trading and derivatives strategist at Charles Schwab.
"For the last two years, we haven't had that much of a pullback," Mazzola told Investor's Business Daily's "Investing with IBD" podcast. But now that five of the Magnificent Seven stocks are in bear-market territory, investors who have wanted to buy at a discount finally have that chance. However, Mazzola shared some of his strategies for getting stocks at a discount in any market, or at least getting paid while you wait.
Selling Puts: Buying Stocks At A Discount
One of Mazzola's favorite strategies is selling puts. It's conservative enough that if you set the cash aside to purchase the stock in case of assignment, you can even use the strategy in Individual Retirement Accounts, or IRAs.
If you have a price that you'd be willing to pay for the stock and you set a limit order at that price, the order might never get filled, Mazzola explained. But selling a put lets you purchase the shares if they come down to that price, plus you get some premium to sweeten the deal.
What if the stock never pulls back? That's OK too. Then you just keep the option premium and you've created your own income stream.
Audio Version Of Podcast
But what about when there has already been a pullback in a stock market correction? Because of the general upward bias in the stock market over long periods, Mazzola doesn't employ too many bearish strategies.
Hedging using long puts to protect your portfolio is certainly one way to help lessen the sting of a pullback. But once a pullback has happened, Mazzola will use technical analysis to identify important levels and then use call spreads and put spreads to build a strategy around his thesis of what he expects the market to do.
Stocks To Watch In A Stock Market Correction
Consumer staples often get attention in stock market corrections, and Monster Beverage looks poised for a breakout, according to Mazzola, with some potential to run.
How does Mazzola play stocks on the verge of a breakout? Call debit spreads. "I'll buy a call where the stock is at and sell a call where I think it's headed," he said. He looks for a 3-to-1 ratio of reward to the risk, ideally.
With something like Chevron, he might go with a longer-term option, or LEAP. With an expiration nine months out, an at-the-money call will let you participate in a lot of any expected move with a little less capital at risk.
Given that some defensive stocks are dividend plays as well, it's important to recognize holding a call option isn't going to get you that dividend. For Crown Castle, a real estate investment trust (REIT), the 6% yield is attractive as an income play. That's a situation where you might be better off holding the stock to capture that dividend, Mazzola noted.
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