An apology

Well I have to apologize to my subscribers for the little bit of spam that has been coming from my feed lately.

It seems that the company that runs my feed had a little piece of background program that I did not know about was turned on - so consequently you received my personal links that I use.

It is a cool program however I was linking to other interests of mine and not realizing that it was being sent out to all of you. I have corrected the problem and apologize for the extra email you have received.

If you are interested in doing similar links you can try out the program called del.icio.us - you can even help me out by adding this website to your links in del.icio.us. In any case I apologize for the off topic information.

Now back to our regularly scheduled program - exit strategies.

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Christopher Smith at The Option Club

Christopher Smith is the owner of the The Option Club

He has been trading for years using conservative option trading strategies. As part of his website he has a yahoo group that I belong to and he just made a post that is so relevant to trading conservative options. Here it is…

“If you accept that options represent a zero-sum game, then you have to accept that if you consistently and repetitively open positions, long or short, that your return will be zero, less your commissions and trade overhead. So, if you consistently open a short options position 1, 2 or 3 standard deviations out from the current positions, it simply means that the majority of those positions will expire worthless. It also means that some smaller percentage of those positions will expire in-the-money.

I have been trading out-of-the-money credit spreads and iron condors on the major indexes for years, now. I have made many, many mistakes. I have made and lost money. I also like to think that I have learned some things along the way.

One of the things I have learned is that you cannot rely exclusively upon a standard deviation to plan your trade and expect to be profitable over the long term. You must do something that provides you with an edge; i.e., a positive expectancy. That edge can potentially be acquired through various means. Superior market analysis, effective trade adjustments, etc.

The critical component in determining whether a trading methodology is ultimately profitable is risk management. Recognizing and managing losses is what I have found separates the successful, profitable traders from the majority. ”

Christopher Smith
TheOptionClub.com

I agree that in order to be successful in the options or even the stock trading world risk and capital management is the key.

Dan Beatty
Conservative Options

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Using Volatility with earnings

OK now many of you know my feelings about earnings trading is that it is as close to gambling as you can get while trading. Well I am going to show you a technique I use to trade earnings using volatility to my advantage.

Earnings season comes but four times per year, check out www.earnings.com to find out when specific stocks are announcing their earnings for each quarter. You need to plan ahead for this strategy. This will be a straight call play, played two to four weeks prior to earnings.

First good fundamentally sound stocks usually have a runup (a small bull trend) just prior to an earnings announcement. This is a typical trend - it does not always hold true but it is a trend, however in our play it will not matter as long as the stock does not drop a lot prior to earnings. So the first step is to find good stock with good fundamentals. There are many screeners out there to find such a stock I use the one at Income Trader or you can use the screener at Options Xpress or Yahoo has a screener. The one from Income Trader is definitely for beginners because you need to know nothing about fundamentals to use it. It basically says Good Stock. Look through the “good stock” list and find one or two in a bull trend.

Second, You can look at the technicals of Slow Stochastics and MACD as well as support and resistance to determine where you think the stock is headed. Preferably up!

Third look at the Volatility chart for the stock and compare the current or implied volaility to the historic volatility. Now as you can imagine earnings is a time in which the stock price can change dramatically so the implied volatility is going to go up the closer to earnings you get. What we want to see, 2 to 4 weeks prior to earnings, is an implied volatility at or below the historic volatility. If it is already above the historic volatility, then we are already too late as the volatility is already priced into the options. Remember we want to buy low and sell high with volatility.

Fourth choose your option. As a conservative trader I choose the option strike at one step in the money. For example if the stock was trading at $53, I choose the call option at a strike of $50, the first in the money option strike. If you have an extremely small account you can choose out of the money options however there is more risk involved with those as there is no intrinsic value, meaning it is easier to have a 100% loss.

Then if you have timed your technicals correct looking at the stock graph and the volatiltiy graph, the option price should increase with the stock price (intrinsic value)but more importantly the option should increase the closer you get to earnings because of the increase in volatility (part of time value). Close the trade a day or two before earnings.

Lastly, I will use a trailing stop on these because many times news will come out a day or two before earnings suggesting that the company is expected not to make earnings. Also many investors pull their money a day or two prior to earnings to avoid any bad news caused by earnings and to take profits from the small run up, this causes the stock to drop in price.

Comments or Questions?

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Market Crash new support and resistance

Well with last weeks crash there is definitely a change in the support and resistance lines for the market. Lets take a look at where we are at now…

QQQQ - Support = 42 which is around the 200d ma / Resistance = 44 or the 50d ma
SPX - Support = 1380 (200d ma stronger at 1365)  /  Resistance = 1420
OEX - Support = 630 around the 200d ma /   Resistance = 650 weak (660 stronger)
DJ30 - Support = 12000 (200d ma around 11950) /  Resistance = 12500
RUT - Support = 770 (220d ma 760) / Resistance = 800 strong

So if you look at the charts the next solid line of support for all the indices is the 200d ma. If we break that on one of the big indices such as the DOW or the SPX, then a new bear trend will follow suit.

My opinion is that we will stay above the 200d ma and be neutral for awhile. With the increase in volatility new trades should be easier to find.

Next post I will continue the discussion on volatility.

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