Mega-cap stocks represent the stocks of the largest publicly traded companies in the world like Apple, Microsoft, or Amazon. These companies have market caps that are over $200 billion, so mega-cap stocks enjoy a lot of popularity with options traders who are drawn to these positions for their stable price movements, liquidity, and considerable trading volume.
What makes options trading on mega-cap stocks attractive to traders is that they are easy to enter or exit quickly without affecting the price and they can be traded using strategies that perform well when the market conditions are stable or sideways. Our guide will outline everything you need to know about the risks and opportunities associated with trading these mega-cap stocks. You can also enjoy a detailed rundown of the best trading strategies and techniques for securing a profit from these stocks.
Understanding Mega-Cap Stocks in Options Trading
Mega cap stocks are the largest publicly traded companies worldwide, those that have a market cap that over $200 billion. These companies have considerable influence over global markets because of their sheer size and the financial power they hold. Though they tend to have less volatility and offer more predictable future returns for those that trade them, mega cap stocks performance can also affect entire indices and sectors, for good or bad.
- Stability: Mega-cap stocks are primarily characterized by their low volatility, steady returns, and overall stability. They can be enticing to traders who seek a good blend of safety and growth in their investments.
- High Liquidity: Mega cap stocks have a high level of trading activity which lets traders buy and sell large quantities of shares without it having a major impact on the stock price. These positions are easy to buy and sell quickly and easily.
- Strong Fundamentals: These stocks tend to enjoy strong financial health, such as a dominant market position, consistent revenue growth, solid balance sheets, and high profitability.
Due to their significant trading volume, stable price movements, and liquidity, mega-cap stocks are a popular choice with options traders. The stocks are well-known for having a strong market presence and consistent performance which creates a predictable environment that can be ideal for many options traders.
Opportunities in Trading Options on Mega-Cap Stocks
What are the best scenarios for trading mega-cap stocks? We’ve highlighted the best opportunities that come for traders who add mega-cap stocks positions to their portfolios. A lot of the profit potential stems from the characteristics of the stocks themselves, which offers traders a much better advantage over trading lower-level stocks.
High Liquidity and Tight Bid-Ask Spreads
Liquidity represents how easily and quickly an option can be sold or bought without it having a profound affect on the price of the underlying asset. Liquidity can significantly benefit traders with faster order execution and minimal slippage.
Bid ask spreads are the difference between the highest price a buyer will pay for an asset and the lowest prices that a seller is willing to accept. This facet of options trading is critical in determining the supply and demand dynamics of the market.
Mega-cap stocks are known for being highly liquid and having narrow bid-ask spreads. If you’re comparing Apple options to a mid-cap stock, you’ll find that Apple stock will have a large number of buyers and sellers readily available in the market to engage in business. The Apple stock will also have a minimal difference between the price someone is willing to buy and the price someone is willing to sell.
Abundant Options Volume and Open Interest
Mega-cap stocks are based on the largest publicly traded companies around the world so there’s a significant amount of trading activity going on each day. It shows that there’s a high level of interest from a variety of traders. These stocks also have high open interest, which means that there are many outstanding open options contracts. Again, this is another sign of trader interest but also of a strong trend in the price movement.
High open interest and volume both provide better entry and exit points, making mega-cap stocks highly liquid assets. Anyone who is trading these positions can enter or exit for a relatively decent price where there’s potential to secure a profit.
Lower Implied Volatility (IV) in Stable Market Conditions
Mega-cap stocks tend to have lower IV which results in more predictable price action. These stocks are far more stable, on average, than lower-level stocks. Dealing with mega-cap stocks allows traders to enjoy less expensive hedging as well as lower option premiums. Plus, traders only have to deal with smaller price fluctuations by comparison.
As a result of the lower implied volatility rates, trades using mega-cap stocks have prime opportunities to buy options or volatility. These are some of the best strategies to take advantage of these low IV environments:
- Debit Spreads: Traders must buy an option with a higher premium and sell an option with a lower premium, securing a profit when there’s a widening in the price difference between the two options.
- Naked Long Puts: The goal of this strategy is to profit from an anticipated increase in the underlying asset price. Perhaps the prices rise considerably. The traders can simply exercise their call option and buy the asset at a lower strike price. To secure a profit, the trader must then sell the asset at a higher market price.
- Naked Long Calls: The trader sells put options without holding a corresponding short-sell position in the market.
- Diagonal Spreads: Because they combine a positive theta with a bullish IV exposure, diagonal spreads are a great choice for traders in low IV environments. For one thing, they are relatively affordable positions to take on. Then you have the fact that the diagonal spread is good for protecting investments from shape moves in IV that would typically hurt a short premium trade.
- Calendar Spreads: These trades tend to do well in low IV scenarios because the time decay of options with longer expirations is more pronounced. It results in the best all-around benefit for the leg of the spread that has the long-term option.
Earnings and Event-Driven Volatility
Earnings reports and major corporate events create profitable opportunities because these are moments when the market tends to experience volatility due to the uncertainties associated with many of these announcements. You find a lot of these opportunities to trade volatility on these mega-cap stocks.
Strategies
Buying straddles/strangles before earnings reports can be highly beneficial for traders who are dealing with bigger stocks like Amazon, Apple, or Microsoft.
- Strangles: This move is best used when the trader expects a considerable price move in the underlying asset. The long strangle, in particular, is best with mega-cap stocks and involves buying a call-and-put option at the same time. They come with the same expiration date but a different strike price. Strangles are best used before events like the releases of an earnings report or new product releases.
For the strangle to work out correctly, the underlying asset needs to move significantly to break events and secure a profit. It works well for traders who think the current IV for the option is too low. As a result, using strangles is a high risk-high reward proposition.
- Straddles: Buy and sell both a call and put option for the same underlying security where the goal is to profit from the ensuing price volatility. Traders don’t have to correctly predict the direction of the price movement to secure their profit. The long straddle is the best course of action going into an economic report release or any sort of substantial market news. The trader is expecting the security’s price to rise or fall significantly but they aren’t sure which way it will go.
The great aspect of using the straddle strategy is that there is technically unlimited profit potential, but a clearly defined risk profile. As long as there is price volatility in either direction, the straddle will profit the trader.
Strong Fundamental and Technical Analysis Opportunities
Strong fundamentals on a mega-cap stock refers to a company that enjoys a constant revenue stream, a dominant position in the market, and sound financial health. These strong fundamentals can signal a safer investment opportunity to traders. Because they tend to have more stable price performance in the midst of market fluctuations.
Traders can use technical indicators on mega-cap stocks for better entry and exit points. Good examples of these indicators are moving averages, MACD (moving averages convergence divergence), or the Relative Strength Index. These helpful tools let traders see potential breakouts or reversals for trends by identifying key support or resistance levels.
Example
Traders can take two indicators, moving averages and RSI, to find out the current trends with Microsoft’s stock. It can be helpful to look at the 50-day or 200-day moving averages to pinpoint the trend direction for the stock. RSI can be used to find out if the stock is considered to be overbought or oversold. These technical indicators can provide invaluable information for the trader on where the best price points are to enter or exit the position.
Traders can get a bullish signal from the Microsoft stock when they observe the price crossing above the 50-day moving average while the RSI is simultaneously in an oversold or neutral zone. A bearish signal would be if the price crosses below the moving average coupled with a high RSI (overbought conditions).
Risks of Trading Options on Mega-Cap Stocks
While traders can have a lot of success trading options on mega-cap stocks and there’s certainly a lot to be said for their stability amid price fluctuations, there are also some risks that come from these investments. Mega-cap stocks can have, from time to time, more expensive option premiums, limited gains compared to mid-cap stocks, and the potential for IV crush due to overcrowded trading. We’ve outlined the risk below for your convenience—stay in the know about how these trades could go south!
Expensive Options Premiums
In a lot of cases, mega-cap stocks have higher option premiums due to their large market capitalization—high stock prices lead to costly options contracts. All of this can lead to higher implied volatility as the market expects larger price swings and, therefore, inflates the cost of these stocks’ options contracts. All told, the mega-cap stocks have higher premiums due to the high-risk-high-reward nature of these trading opportunities.
Comparison of Premium Costs
Mega-cap stocks represent companies that have a market value above $200 billion, while mid-cap stock options represent companies that have a market value somewhere between $2 billion and $10 billion. The premiums are generally higher with mid-cap stocks because they’re considered to have higher growth potential, but they carry a lot more risk.
Lower Volatility Can Limit Gains
Because mega-cap stocks are generally more stable than mid-cap stocks, its lower volatility can limit gains due to its large size and its established market position. It results in these stocks being more restricted in the ability to grow rapidly. Ironically, traders will typically see slower returns with these mega-cap stocks.
Example
Let’s compare the options movement for a mega-cap stock like Tesla and a mid-cap stock like Johnson & Johnson.
– Tesla: This stock usually has higher implied volatility because of the past history of the stock’s volatile nature. Put options are usually more expensive than the call options due to the stock’s significant skew toward the downside. Large swings are typically expected around earnings announcements which typically results in higher trading volume for calls and puts.
– Johnson and Johnson: The options activity for this company usually shows neutral sentiment, though many traders anticipate potential downward price movement in the stock. With its slight bearish tilt, Johnson and Johnson has a nearly even put-call ratio , but a much higher volume of put contracts compared to options contracts. The volume is moderate in relation to the average daily volume and the current implied volatility is considered average.
Sudden Market-Wide Moves Impacting Mega-Caps
When macroeconomic events occur, it can greatly influence the overall economic environment where these major companies operate which in turn can affect significant factors like access to capital, consumer spending, or future earnings prospects. Some macroeconomic factors affecting these mega-cap stocks would be things like the unemployment rate, inflation, gross domestic product, currency fluctuations, or government policies.
Case Study
A prime example of large macroeconomic events impacting the health of mega-cap stocks would be when there are interest rate hikes and they hurt the big tech companies like Microsoft or Apple. Higher interest rates can raise the borrowing costs for business expansion which eventually leads to the hampering of their stock growth.
Overcrowded Trades and Potential IV Crush
When many traders are dealing with the same stock (this is the case for many mega-cap stocks), there can be an event known as “IV crush” that can occur before significant events like an earnings announcement. What happens is that the increased demand for options will drive implied volatility to higher levels before the announcement. But there’s the chance that the price movement that actually occurs isn’t as dramatic as traders were anticipating. What happens from there is that the inflated implied volatility completely falls apart and it leads traders who bought the options at a higher price to incur some significant losses.
Example
A good way to illustrate IV crush on mega-cap stocks would be a trader who buys up Amazon options before an earnings announcement due to a spike in implied volatility ahead of time. Post-earnings, there’s a sudden volatility drop on Amazon options because the report was positive. Now that the uncertainty is past, the price of the options drops dramatically, causing the trader to be stuck with the options they bought at a higher price.
Best Strategies for Trading Options on Mega-Cap Stocks
Let’s turn our attention to trading options on mega-cap stocks and the best trading strategies and techniques for making money with these stocks. To give you a little preview before we dive in, we’re talking about selling covered calls for consistent income, using straddles and strangles for securing profits around earnings, and a few other significant moves.
Selling Covered Calls for Consistent Income
If a trader already owns part of a mega-cap stock, they can sell call options as a way to generate income from a stock position. Traders can receive a premium for selling the call options, and it doesn’t matter if the buyer exercises the option or not. Generating passive income from mega-cap stocks is best when the market is either down or flat. It’s also ideal when a stock is expensive to its fair value or when traders are moderately bullish.
Some of the benefits that come with selling covered calls, aside from collecting a premium upfront, are getting some downside protection, lock in a higher price for the trade, and to earn income without selling the stock (in the event that the buyer doesn’t exercise the option).
Example
A trade already owns a portion of Microsoft by holding stock, so they sell a covered call to generate a premium upfront. The premium can be used to help offset some of the potential realized losses. The trader gets to keep the premium from the sale and it doesn’t matter if the buyer doesn’t exercise the option. In theory, traders can earn income without selling their stock—they’re holding their shares and are still making money.
Using Vertical Spreads to Reduce Costs
Using vertical spreads allows traders to reduce their overall cost by buying and selling options at the same time with different strike prices and the same expiration date. Traders can enjoy a lower net cost to enter the positions due to the trade offsetting the premium paid for one option with the premium received by selling the other.
Bull and bear call or put spreads can help traders manage risk and profit from price differences in the stock. These moves not only limit risk and profit potential, but they can even profit from time-value decay. A few other benefits are a lower cost to write options, generating income with limited risk, and they can help traders buy a stock at a lower price.
Case Study
Bull spreads work well when traders expect a moderate rise in a stock price, so a good stock to use this strategy with would be Nvidia, which has seen strong growth over the last year. The bull spread would work well with Nvidia because traders can limit the risk and reduce the net premium spent.
Earnings Straddles and Strangles
Using earnings straddles and strangles for high IV plays are best when most traders are anticipating a big price movement in a stock. These moves are mainly centered around a significant event like an incoming earnings report. Strategies like straddles and strangles do best when there’s high volatility and they can help traders secure a profit regardless of which direction the market goes. This is great for traders because they don’t have to get the direction right to make some money.
Example
Let’s say there’s a trader who believes that Amazon’s stock price is likely to experience some significant fluctuation pre-earnings. The trader would execute a straddle move where they buy a call and put option at the same time with the same strike price. They would be betting on large price movements in either direction. No matter which way the Amazon stock price moves, the trader will be profitable because the straddle’s success hinges on volatility occurring.
Iron Condors for Low-Volatility Mega-Caps
The reason iron condors work well on mega-cap stocks is in their overall design. They profit from stable conditions and a lack of price movement, which mega-cap stocks are well-known for. These bigger companies are known for their relatively low volatility which stays within a predictable change. These are the ideal conditions for using an iron condor to turn a profit.
Step-By-Step Setup for an Apple Iron Condor
Follow these instructions for getting an iron condor going while trading mega-cap stocks that have low volatility.
- Choose an Apple stock you’d like to use for the iron condor. Look for something with high open interest, tight bid-ask spreads, and high liquidity.
- Choose the expiration date. Keep in mind that anything with an expiration date of two weeks or less is much more susceptible to time decay, while contracts with expirations longer than 60 days out have slower decay but are more affected by volatility.
- Select the strike prices. The short put and call should have strikes where the likelihood of having them expire in the money is low. Use out-of-the-money strikes on the long put and call.
- Figure out the net credit you would receive once the options are sold. Once you have this number, you can find out what your maximum profit would be if all goes well with the strategy.
- Execute all four legs of the trade in one move (the iron condor). Once everything is set up, submit the trade. Then, oversee the trade until its expiration date. As you monitor what is happening, you can make changes or adjustments as needed to your strategy.
LEAPS for Long-Term Investors
LEAPS options stand for long-term equity anticipation securities. These are contracts that expire more than a year in the future and the expirations can be as far away as three years, depending on what kind of contract you choose. LEAPS options are good contracts to use when dealing with blue-chip stocks as they can provide some significant leverage for traders.
LEAPS lets traders control a large amount of underlying stock with a relatively small investment upfront. Not only can you limit the max loss to the premium paid, but you can also increase potential gains from significant price movements.
Example
Buying LEAPS is best for traders who believe the stock will rise over the long term. This bullish outlook would make investing in Google stock a good choice for long-term bullish exposure. Since the Google stock is likely to keep rising over the course of a year or two, the trader can be making money with LEAPS options and still have a long enough time horizon to not worry about the option expiring as worthless.
If you’re looking for additional information on LEAPS options and how they work, we’d recommend checking out this guide: LEAPS Options 101.
Key Takeaways and Final Thoughts
What makes options trading on mega-cap stocks like Apple, Microsoft, or Amazon attractive to traders is that they are easy to enter or exit quickly without affecting the price and they can be traded using strategies that perform well when the market conditions are stable or sideways.
Mega-cap stocks can provide significant risks for traders, but there are several great opportunities these stocks can offer traders who are willing to take a chance. The success of trading mega-cap stocks is choosing the right strategies based on the current market conditions.
Risks
- Expensive option premiums
- Lower volatility limits gains
- Sudden market-wide moves can impact stock value
- Potential IV crush
- Overcrowded trades
Opportunities
- High liquidity
- Narrow bid-ask spreads
- High volume
- High open interest
- Lower implied volatility
- Opportunities to profit from event-driven volatility
- Strong fundamentals
We’d encourage all traders to manage risk carefully and utilize stop-loss strategies, simply due to the risks involved with mega-cap stocks. Keep in mind that you can use a wide range of different strategies for locking in a profit:
- Covered Calls—Best for Generating Income Through Premiums
- Vertical Spreads—Reduce the Costs of Trading Mega-Cap Stocks
- Straddles and Strangles—Best for Trading Around Earnings Announcements
- Iron Condors—Best for Low Volatility Trading Opportunities
- LEAPS Options—Best for Riding Long-Term Trends
