How my friend at Goldman Sachs trades options


I am privileged to have a friend from graduate school that is one the smartest options guys at Goldman Sachs.

I see a lot of Goldman Sachs research on options, which includes a weekly report with all of their recommended option trades, as well as any published research, white papers, and studies that Goldman has done on options.

Given that most of the readers of this research are controlling hundreds, if not billions, of dollars, this is pretty special research.

I have been reading Goldman research on options for years. And I always pick up a ton of incredible trading tips and methods that the best investment bank in the world uses to analyze and trade options.

Today I will give you some nuggets that I think average trader likely don’t know, and need to know:

1) Implied volatility (“vol”) is the key element in analyzing options. When implied volatility is high, an option can become too expensive. When implied volatility is low an option can become cheap. That can create a trading opportunity. I should note, it all depends on why its high or why its low. Let’s assume there is nothing macro or micro level that has pushed vol around. Now, to know if vol might be cheap or expensive, you need to compare the current vol to its history. Where is it trading relative to the past three months, the past twelve months? Follow this screen and you will improve your options trading dramatically.

To get implied volatility for options you need a good platform that provides these statistics.

If you don’t have this type of platform, and most of you probably don’t, there are some ways to tell if implied volatility is low and the options are cheap. I call this the “eye test.” Look at a chart of the stock or ETF from which the option is derived. If the stock or ETF has gone sideways, or if its at a double or triple bottom, or a double or triple top pattern, there is a good chance implied vol. is low and the options are cheap.

Also, if the earnings announcement for a stock is close — within 1 to 2 weeks — you will likely find that implied volatility will be high, and the options will be expensive. That is why many people who have purchased options before earnings never make money. Even though the stock goes up, the option they buy already had it priced in through the inflated vol.

Now, onto tip number two …

2) You need to have a catalyst to trade options! There must be something that moves the stock or etf in a dramatic way such as a merger, a major corporate announcement, an activist investor, a major conference call/investor day, a new product launch, a major economic announcement, a change in the fundamentals of the economy, earnings announcements (but make sure you buy the option at least 2 weeks ahead of time), a potential sale or divestiture of the company. If you don’t have a catalyst such the ones listed above, don’t spend your money on options (unless you can actively hedge it).

3) There are two techniques I like: Using options as an outright bet on a spike in vol …and using options as a stock replacement strategy.

When focusing on cheap options with low implied volatility and a catalyst, you are implicitly long volatility (you’re betting on a move higher in vol).

I’ve talked about the stock replacement strategy many times on this blog. Its using options as a leveraged proxy for the stock or ETF. You look for a quick move in a short period of time. When you are using this secret stock replacement strategy, you must only buy in-the-money options.

I use both of these techniques when I buy options.

Bottom line this is just a little insight into how the richest most powerful investment bank in the world approaches options. And it reinforces what I always tell you on this blog — and what I do for my subscribers in my premium service (The Billionaire’s Portfolio). You have to follow and know what the best, most influential investors in the world are doing.

William Meade