CNBC’s Fast Money Man: Peter Najarian on Options, Part 2

April 25, 2008
Pete Najarian

Last week we presented you with Part 1 of our conversation with Pete Najarian, options guru with CNBC’s “Fast Money” program. (Click here if you missed the first part of our interview.) Najarian has a long history as an options trader, having worked as a pit trader and a market maker at the Chicago Board of Options Exchange. More recently, Najarian helped found One Chicago, an electronic exchange geared toward trading in futures on individual stocks, indexes and exchange-traded funds.

In the first part of our interview, we learned a little about Pete Najarian’s background and his general philosophy on trading and the options market. Here, in Part 2, we will look more closely at some of his more recent trades, some of his nuts and bolts ideas about entering and exiting options trades, as well as what it is that he loves most about being an options trader.

David Penn: We talked a lot about options trading in general in the first half of our conversation. Can you tell us about one of your best recent trades?

Peter Najarian: Sure. I’ll give you two examples of what we’ve seen. And I’ll give you one example of what we saw recently and why it made so much sense.

Let’s take the United States Oil Fund
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PowerRating). Now, normally we stay away from these ETFs only because you normally aren’t going to get the big bang for your buck with the ETFs. This is because of the fact that it’s an index, you’re not going to see the moves that you can see in like an Apple
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So the ETFs in general don’t move. But oil was trading up real recently, trading somewhere near that $110 range for a period of more than a few days. We found it interesting and it made a lot of sense that if there were to be a pull back, the USO would be a great vehicle to use to be able to participate.

Also there was plenty of put buying, and put buyers didn’t stay in March because of course, maybe the ETF wouldn’t move that quickly. So they moved to the April options, instead, and they were buying both at-the-money and just out-of-the money puts in April at a pretty aggressive clip. When I say “they”, I mean institutional-size traders were buying those options.

Because of that the trade made sense. It didn’t work immediately. It took more than a week before oil broke back through $100.

Now that was a pretty dramatic move, but it was a move that everybody sort of was waiting for and looking for. But “the smoke” came to us in the form of those USO put buyers that were taking positions in April options..

David Penn: It sounds like a textbook trade.

Pete Najarian: There had to be some patience. It didn’t happen right away. And I think that’s the toughest thing for folks that are trading options: they have to understand that there is a timeframe and that you have to have that timeframe for something to play out.

In the case of this USO trade, it didn’t happen the day after; it didn’t happen even a week after traders started buying the puts. But it happened in a timeframe that allowed for the trade to come around. Then we got to watch oil crack through $100 a barrel after trading at $111 just days before. Trades like this make a lot of sense.

“We really liked the idea that sooner or later there’s going to be some selling in oil and put some pressure back on after this huge run…”

David Penn: And even though you aren’t a big fan of trading ETFs, necessarily, you liked the opportunity in USO?

Peter Najarian: We bought the same puts that the most aggressive buyers were purchasing. We decided that the trade made a lot of sense for all the reasons I mentioned.

It seemed like oil had made a substantial run, and maybe it could still keep going higher. But we really liked the idea that sooner or later there’s going to be some selling in oil and put some pressure back on after this huge run. The same thing happened with another ETF, Same thing for gold, StreetTracks Gold Trust,
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David Penn: And you just used naked puts in that USO trade?

Peter Najarian: Yeah.

David Penn: Do you consider yourself technically oriented, fundamentally oriented, a blend of the two in terms of coming with specific trade ideas?

Peter Najarian: I would say an absolute blend.

We’ve got our proprietary systems that we run and, quite honestly, my job all day long is to monitor these systems as best I can and eliminate reasons why I’d want to do the trade that I’m seeing in front of my face.

I go through the elimination process. So, on an average day, we have hundreds of trades that fit all of the metrics that we have laid in front of ourselves of what we’re looking for. But I try to look for every reason in the world not to do the trade. If I can’t find enough reasons not to do the trade, then I’m going to do the trade. I’m going to write about it and talk about it and hope it works.

And after all that, it still doesn’t always work. There is no 100%. I hear a lot of folks out there talking about how great this and that are. There’s still, I think, some luck involved, but by using enough different reasons to focus on a particular option, I think overall our approach works well.

David Penn: Without asking you to reveal too many secrets, could you give us an example of a sort of technical tool that you might use, and a certain fundamental tool just so people have some ideas of the sorts of things that you might look at?

Peter Najarian: Oh, as far as the fundamental side?

“We are seeing the S&P 500 show a substantial amount of support around 1280 and we’re seeing a resistance up there at 1330.”

David Penn: Maybe fundamental and technical. Maybe one from each?

Peter Najarian: Sure. Technically, I love the charts as much as anybody else does out there. There are plenty of patterns, in fact we are in one right now.

We are seeing the S&P 500 show a substantial amount of support around 1280 and we’re seeing a resistance up there at 1330. So, granted, that’s a full 50 point range. But in the broad scheme of things, the S&P 500 has been in a relatively tight range and it has been in that range for quite a while now. As volatile as the markets have been since we started 2008, we’ve seen a lot of volatility in the markets. I mean, everything. The S&P has really stayed very, very close to those numbers.

David Penn: So support and resistance is one example of a technical or chart-based tool that you rely on?

Peter Najarian: There’s not exact, but if you’re using them, they have been great tools.

And then in addition to just know that kind of thing about the S&P 500–or the stock you are looking at–then you go back to the fundamentals.

I look at a stock like Cisco Systems
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And then I’m looking for a catalyst that would make me want to think “Now’s the time to own something like Cisco.”

I’m not necessarily advocating Cisco at this time. I’m just saying that knowing the stock from the fundamental standpoint–PE level and the infrastructure build-out, the networkers going in with all these SmartPhones and the 3D and all the rest of that â€¦ I like all those different reasons why Cisco would be a stock that, if I started to see some unusual options activity that made me start to think, “Okay, well, I’m right and here comes a good timeframe because they’re buying the XYZ month â€¦” then I would start to really start to get excited about something like Cisco or Juniper or whichever stock might fall into the category.

David Penn: Interesting.

How much does the price of the option, whether the option is overpriced or not, play into your trading?

Peter Najarian: Well, I think it is as critical as anything when you’re getting involved with options to have the knowledge that you’re talking about in terms of valuation. You’ve got to have some knowledge of what the levels are and having some understanding of the history of where those levels have been.

Other than that, I think the other next step is having some form of system that can be the tool that you can lean on.

There are systems out there that are offered through many of the various online brokers and so forth. I couldn’t even begin to go through the list, I know it’s a long list of folks that offer these things. But I would pick an online broker that has some of those kinds of tools available for me so that I can see the levels of volatility for a given stock and the volatility of the options.

So I think (a) you’ve got to have the knowledge and (b) you’d want to have some sort of a resource that you can lean on to find the specific answers because you just can’t go in and nakedly just think that, well, I’ll buy these options. And not knowing why they’re too high or too expensive presently would be foolish.

You really have to have some knowledge going in. And you need those tools.

“When you’re wrong, you’ve got to be able to cut your losses, and you’ve got to know that going in.”

David Penn: When it comes time to exit a position, what are the ways that you want to get out of an options position?

Peter Najarian: When you’re wrong, you’ve got to be able to cut your losses, and you’ve got to know that going in. As a general rule, and believe me, this is a very, very general rule, if an option has moved negatively from our entry point by 50%, we will cut it.

Like I say, that’s a general rule because there are some flexibility on why we may not stick to that. But in general, that’s a rule.

David Penn: That sounds easy to remember and stick with.

Peter Najarian: It’s funny. People will hold something that’s not working forever. But something that is working, they also tend to be a little bit giddy and then they seem to change their mode once things are working.

On the upside, we’ve always tried to stick with the idea of selling into strength. And when that strength is there, say if an option doubles, you have to sell some of the position–at least half of it. Because if you have sold half, then everything you own is free. Say if an option you paid $0.50 for that is now $1.

So based on that, if things work well enough, you’re going to be owning the rest of the position for free. This gives you an opportunity to say: “Alright, I do think there’s a heck of a lot more downside or upside to these puts or calls. So I will hold this longer and I’m going to really see where this thing goes.”

And that’s where you have the opportunity to let it sort of fly and ride. Let the winners run.

David Penn: Do you subscribe to the fairly traditional ideas in terms of in-the-money, at- the-money and out-of-the-money options? The idea that the shorter timeframe you’re working with, the deeper in the money you want to be as a general rule?

Peter Najarian: No. I don’t. I think every situation is slightly different. So I don’t think that I could ever categorically say I’m going to use this option because of this reason. I think it all really does depend on what it is that I’m doing. But in general, I normally stay away from the in-the-money options and primarily stick with the at-the-money or just out-of-the-money options.

David Penn: That’s interesting. Why so?

Peter Najarian: That’s just looking for the true bang for your buck. I mean, that’s where the delta of an option moves much more rapidly to the upside. With the in-the-money options, yeah, it’s going to move like the stock. But the other option, the out-the-money option, if it accelerates, it really, truly accelerates. The options starts to move even faster with the stock.

I just generally like the less risk and less cost of the at-the-money and just out-of-the- money options.

David Penn: What is it, if you can say a thing or two about options trading that you enjoy compared to maybe if you were trading stocks or forex or something else? What is it that really â€” this is really why I like the options?

Peter Najarian: I guess I really like the options because they do allow for leverage where you can be involved in many more positions for similar cost–and with potentially much more gain overall.

For instance, if you had $10,000 that you’re able to put into the market, you’re going to chew up a lot of that on just one stock more than likely. Maybe one or two positions in a stock or pair of stocks.

That’s what I love about the options. It gives me the ability to spread around and be in more places at the same time.

CNBC’s Fast Money Man: Peter Najarian on Options, Part 2

BUY THE FEAR, SELL THE GREED

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