For eons, most investors treated hot stocks the same way. They sold stocks with gains of 100% or more, and they invested the profits in underperforming stocks with a good chance of advancing.
But financial markets have a new attitude, exemplified by innovations like prediction markets and zero-dated options: Many people view the markets as a casino. The old ways of thinking are increasingly ignored because they conflict with this gambling mind-set.
Now many stock gamblers believe hot stocks get hotter. This has been reinforced by their experience. Retail investors have emerged in the past five years as a powerful force that, en masse, has disproved investment disciplines like “Buy low and sell high.”
The new mantra is “What is hot can get much hotter—if enough people will it to be thus on social media.” For proof, check out the parabolic growth of meme stocks, which have often benefited from the power of the retail trader.
All these market phenomena are challenging the legitimacy of long-term investing. Why wait to get rich when you might be able to do it overnight?
The “Buy higher and higher” rule applies to many stocks, but silver might be the mascot of the movement. The iShares Silver Trust exchange-traded fund (ticker: SLV) is up 254% over the past year, dwarfing the returns of just about everything else.
In early January, we suggested investors prepare for the iShares ETF to advance to record highs because precious metals were exhibiting a rare trading phenomenon: price insensitivity. Investors were buying silver regardless of the price, often to offset geopolitical uncertainty.
Our trade returned almost 1,000% in less than four weeks. The position expires on Feb. 20, but taking profits now would be prudent.
Rather than rotating away from silver toward market laggards, we will illustrate how to use options to handle the “Hot stocks get hotter” mind-set, but we will do so in a way that maximizes gains and limits losses. The strategy is a template for trading sizzling hot stocks.
With the iShares Silver Trust at $100.59, investors could buy the March $105 call option and sell the March $120 call for about $4. If the ETF is at $120 at expiration, the call spread is worth a maximum profit of $11. Should it expire below $105, the trade fails.
A call spread—buying one call and selling another with a higher strike price but the same expiration—limits risk and benefits from an advance. (Calls give buyers the right to purchase an asset at a set time and price.)
Unlike buying an asset outright, the options strategy limits losses to the cost of the spread. By selling one call and buying another, the implied volatility expense of a hot asset is also offset. Spreads limit your profit, but the return with this strategy is often 100% or more, minimizing that downside.
During the past 52 weeks, the iShares Silver Trust has traded from $26.57 to $106.70. The ETF is up 52% this year.
A charged debate exists. Some investors are reportedly shorting silver, and others believe the metal is in the grip of a short squeeze that will send it even higher.
The disagreement creates charged market conditions. Every rally is likely to be sold by skeptics and bought by true believers, and every dip is likely to be bought and sold.
This conflict should keep silver edging higher, as short investors will quickly cover their losses and true believers will become more convicted until something wipes them out.
You can sit back and watch the pyrotechnics, or you can exploit the chaos, ideally with a position that limits losses and tilts toward outsize gains.
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