Make Investor Panic Work in Your Favor

Editor's note: Until recently, the bull market had been eerily quiet...

It was almost as if investors had forgotten altogether that stocks don't rise in a straight line forever.

If the market's recent pullback made you nervous, you aren't alone.

This weekend, we're sitting down for an exclusive interview with Alan Gula, editor of our Stansberry Alpha advisory. In today's Masters Series essay, he explains why volatility is a good thing... shows why the strategy he uses can be much more profitable than buying stocks outright... and walks readers through a real-life trade...

Make Investor Panic Work in Your Favor
An interview with Alan Gula, editor, Stansberry Alpha

Sam Latter: Alan, you've been with Stansberry Research for almost two years, and for most of that time, the markets have been very calm. Until recently, stocks had been enjoying a nearly uninterrupted move higher. But we're beginning to see the return of volatility. What do you make of it?

Alan Gula: I know our readers may not feel this way, but I love volatility. Big price swings create tremendous opportunities for traders and investors.

And I've seen some intense volatility in my career. When Lehman Brothers filed for bankruptcy in September 2008, I was working on the distressed debt desk at Barclays Capital. I basically had a front-row seat to the financial crisis as things unfolded.

Those were wild times. And we saw unbelievable volatility in the stock market. The S&P 500 Index fell nearly 5% on the Monday that Lehman went bust. It rebounded a bit that Tuesday, then fell about 5% on Wednesday before finishing up 4% that Thursday and Friday.

During the apex of the crisis in October 2008, the CBOE Volatility Index (or "VIX") reached an all-time high of more than 80. The VIX measures the expected size of a move in the S&P 500 over the next month – up or down. The VIX is the stock market's so-called "fear gauge." Basically, anytime the VIX spikes, fear is palpable.

This month, following a quick, sharp pullback in stocks, the VIX briefly rose to 50. Of course, this is nothing compared with what we saw during the financial crisis back in 2008. But after more than a year of tranquility in the market, investors are much more sensitive to any kind of decline. The recent drop in the S&P 500 was 10% or so over the course of two weeks, but it felt a lot worse than it actually was. So we saw some signs of fear in the market.

Sam: For Stansberry Research readers who aren't familiar with your work, you lead the efforts on our Stansberry Alpha advisory. Of all of the products we offer, what drew you to working on Stansberry Alpha specifically?

Alan: The strategy we use in Stansberry Alpha is one of my favorites because it's a great way to exploit human emotions.

You see, fear ultimately drives the financial markets. When stocks suffer big declines, investors get scared of additional losses. The opposite is also true... When stocks rise sharply, investors experience the fear of missing out.

In Stansberry Alpha, we take advantage of these swings in investor sentiment. And we do this with the help of put options and call options.

Sam: For folks who aren't familiar, can you briefly walk us through the strategy you use in Stansberry Alpha, and explain why it works so well?

Alan: Sure. First, consider an ordinary stock purchase...

Let's say you buy 100 shares of a stock for $50. It costs you $5,000, and your capital is tied up as long as you hold it. If the stock rises, you make money. If it falls, you lose money. Pretty straightforward.

Now, let's consider an Alpha trade on the same stock...

It costs you nothing at the outset. In fact, to enter this position, you get paid $500 up front. And you tie up less capital... You only have to post a small margin requirement.

Over the next year, if the stock rises, you profit from the upside, similar to if you had bought the stock. And if the stock falls after a year, you effectively own the stock for a cost basis of $45 a share. That's a 10% discount from regular investors who bought at $50 a share on day one.

If the stock drifts sideways over the next year, you get to keep the $500 you got paid to enter the position. And you can make the trade all over again.

Sam: To be honest, that sounds almost too good to be true.

Alan: I know it does, but it's not.

The previous example is just a hypothetical, but we recommend trades with similar types of payouts in Stansberry Alpha all of the time. And it's made possible because of options.

As I mentioned earlier, our strategy involves both call options and put options.

Put options are basically a type of market insurance. By buying puts, investors can protect themselves from a stock's decline.

But as fear sets in, nervous investors overreact. When the VIX spikes above 20, it shows investors are rushing to buy downside protection. They're bidding up the prices of put options as they panic. That's our window of opportunity... It's when this strategy really shines.

We then go in and sell short some expensive put options on a particular stock. And we use a portion of the "premium" we receive from selling the puts to buy call options on the same stock.

Last week, with the VIX above 30, we sent out an alert for our most recent recommendation. It was a tech stock that had gotten hit during the market's downdraft. Investors were fearful, and we took advantage of it.

Sam: To help readers visualize this a little better, would you mind walking us through a real-life trade?

Alan: Sure. The trade we recently closed on Dollar General (DG) is a great example.

You're probably familiar with Dollar General. The company is a discount retailer that sells household goods – everything from shampoo to diapers to milk. It has more than 14,000 locations across the U.S.

I'm sure you remember... Back in early 2017, the "retail apocalypse" was talked about a lot in the financial media. As more folks bought the items they needed online through companies like Amazon (AMZN), brick-and-mortar retailers suffered.

The weakness in the retail sector dragged Dollar General's stock down. We thought the fear was misplaced, though. Dollar General was still growing and had great fundamentals. Plus, we weren't worried that Amazon was going to kill it. We knew people would still head to Dollar General to pick up everyday items at rock-bottom prices.

When we opened the position last April, Dollar General's stock was cheap. It was trading at its lowest valuation in more than four years – roughly a 12% discount to its average valuation since going public in 2009.

This was a stock that we would have been happy to own. And if you had bought the stock outright back then, you would have done well. Shares rose more than 50% over the next nine and a half months.

However, using our Stansberry Alpha strategy, we did much better. Last month, right before the market pulled back, we closed the Alpha trade for a gain of 205%.

Editor's note: The recent spike in volatility is just the beginning. When the market suffers another correction, most investors will panic. But folks who follow Alan's advice in Stansberry Alpha will have the opportunity to make thousands of dollars... Like reader Sean B., who reports gains of $1,203 on Corning, $1,150 on Mead Johnson Nutrition, $666 on Ralph Lauren, and more...

In fact, this little-known trading strategy is so powerful, we recently put together a text presentation detailing exactly how this strategy works... and how you can start using it to make thousands of dollars a month. Get the details here.