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Worried about volatility? Try this strategy: Trader

So much for all that gloom and doom.

With the recent surge in the market, not only is the S&P 500 positive in 2016, but more than 40 percent of stocks in the index are now within 10 percent of their respective 52-week highs. But for investors holding on to winners, there is a way to protect profits in the event of increased volatility.

"It might be good to use options as a stock replacement strategy," Dan Nathan said Friday on CNBC's "Options Action," referring to a common options strategy where investors looks to sell stock and use a portion of those proceeds to make a bullish position using options.

"Some of the risks that were really prevalent in the market a couple of months ago that really took [the market and stocks] down may still be there, and you may consider how to stay involved in the name but still define your risk," added the founder of Riskreversal.com.

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In order to utilize this strategy, Nathan suggested investors follow three basic criteria: a stock should have a high valuation; low options prices; and potential for volatility.


As an example, Nathan offered a stock replacement strategy in McDonald's. Shares of the fast food giant are within spitting distance of all-time highs. "I think McDonald's has been the real beneficiary of the sell-off in the dollar," added Nathan. "If the dollar were to rally, McDonald's at 23 times [earnings] could be expensive. So you may want to think about using low options prices to replace stock."

The trade that Nathan recommended was buying the June 120-strike call for $6. This trade makes money if McDonald's shares are above $126 by June expiration.

"That is one way you can use options to define your risk and replace stock," Nathan said.

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  • Melissa Lee

    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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