Something happened during the Great Recession that remains with us today. You can see it any time you visit your favorite fast food restaurant. It’s right there is front of you when you walk to the counter and check out the different offerings. It’s called the value menu.
There are different names for this, depending on where you go, but the concept is the same. These are cheaper items on the menu that you can purchase if you’re on a budget or don’t want to spend $6 for a hamburger. Maybe you’re happy with a basic patty with some cheese in a bun. Maybe you’re watching your pennies and don’t want to blow it on an expensive fast-food meal. Maybe you’re just not very hungry and want a small portion.
Regardless of the reason, the value menu is something that fits your need.
That’s the concept I had in mind when I developed my Value Menu option trade.
What if it were possible to buy options on a quality company at a lower price, with a chance to coming away with a positive gain? The more I examined it, the more I was intrigued. It took a couple of years, but I finally was able to roll out a strategy that I call the Value Menu option trade.
This has become a very popular trading strategy for the students who subscribe to my Morning Lab. I have students who pull me aside when I’m making an appearance at a live event and make a special request. I had a woman grab my arm at a recent event and literally begged me to teach this strategy.
Here’s why people like the Value Menu trade.
• It doesn’t cost very much.
• It has potential to bring in big results
• And even if you bail out, your losses are relatively small
If you are unaware of the Value Menu trade, here’s a quick definition: It is a rules-based, risk-managed, low-cost, speculative directional swing trade option strategy.
Ah, but what does that really mean?
It means that once you identify the candidate, you’ll find the option that doesn’t cost very much. This is the “value” portion of the trade. But you must keep in mind that this is a very speculative trade that will fail more often than it will succeed. However, because your cost to enter the trade is small, the losses are small. But when it succeeds, it has the potential to succeed in grand style. Those are happy trading days!
To find the candidates for the Value Menu trade, you want to look for opportunities that meet certain criteria. If the stock doesn’t fit into these guidelines, I would encourage you to pass on it and move to the next candidate on your watchlist. (By the way, one of the filters on my scanning package is set up to identify stocks that may be worth analyzing for a Value Menu position.)
Here’s the A-B-Cs of the Value Menu trade:
For the Value Menu trade, you want to find a volatile stock, one that moves a lot every day. In the Morning Lab we watch a number stocks that do this nearly every day.
You want the candidate to have weekly options. This increases the volatility of the trade, which is what you want. Remember, you want a stock that is going to move.
You want to buy options that are close to, but cost no more than $2. You want to find the fastest horse in the race, but do it without breaking the bank. Don’t go more than $5 out of the money (OTM). This option may be all time value.
In a recent example, we looked a stock that was selling for $256. In that example we bought the 260 call for $1.06.
To get involved in a Value Menu trade, you want to:
Make sure the trade is headed in the direction of the trend that’s showing on the daily chart. You must see the overall trend, which is why it is so important to know how to read a chart. For the Value Menu trade, you wouldn’t want to buy put options on a stock in a bullish trend. You would be setting yourself up for failure.
Here’s how it works and how you manage the position.
To begin with, you want to protect the entire trade with a stop. The stop is based on the option price, not the stock price. It is typically set around 30 cents.
If the market is volatile or the stock is volatile, you can enter the position by taking half the normal position size and consider twice the stop. Instead of 10 contracts with a 30-cent stop, you might want to consider five contracts with a 60-cent stop. The risk is the same in both of those positions.
Regardless of your trade, never violate your risk management rules. You must be disciplined.
When it comes to getting out, you’re going to leave the position alone until you get stopped out on the entire position or you reach 100 percent return on investment. When you reach 100 percent return on your investment – you’ve made $2 on your $2 investment – you exit half the existing position.
Now you move your stop to slightly above the break-even point. At this point you’re playing with house money. Then you leave the second half of the trade until just before it expires if you’re not stopped out.
The trade is always protected with a stop and the profit on the first half of the position is protected from sustaining any losses.
If you decide to use the Value Menu option trade, you can expect a couple of different things to happen. No. 1, you’re going to get stopped out. This will normally happen within the first 15 minutes of entering the position. Just be aware that this could very likely occur, so don’t get freaked out when it happens. Remember, you’re entering a speculative trade with a low-cost to enter.
No. 2, the trade will work. It’s amazing to watch it when it happens. There’s nothing quite as good as watching the trade take out half your position. You’ve got money in your pocket and feeling pretty good about yourself.
Now here’s the difficult part: You’ve got to keep your hands off the keyboard and let the trade run. You must fight the urge to bail on the trade before it finishes. Remember, you’re playing on house money and your stop is set so you can’t lose. But when the needle moves higher, it’s human nature to feel the urge to jump out early.
Don’t do it.
When you’re in a profitable Value Menu trade, stick with the plan. That’s part of changing your mindset that we talk about all the time in the Morning Lab. You’ve got to be committed to your plan.
If you can do that, the Value Menu trade may be something you’ll want to use whenever you get a chance.