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The following are the four main component factors that will significantly increase your upside probabilities. You should have at least two factors stacked in your favor. If you can get all four factors stacked in your favor, then you have a very high probability options trade.
Overlapping perfect storms on the 60-minute, daily, weekly, and monthly time frames. Usually a 60-minute coupled with a daily mini pup or pup pattern is good for a two-day move. If you add in a weekly or monthly pup or mini pup, that move may stretch out for up to five days with strong momentum. The wider time frames you have, the easier it will be to walk away with profits, as the window of opportunity to do so should be very wide.
Laggards and intrinsic value. Compare the daily and weekly charts of at lest two other same sector companies. A good example is when three other same sector stocks are at daily upper Bollinger bands while the stock in question is just starting to trend up with a daily mini pup. The laggard component acts as a buffer as well. Once money starts flowing into the laggard, it will often continue to move higher to reach equilibrium levels with the sector, even as leaders exhaust and sell off. This is only temporary though, so be aware that the laggard will eventually resume following the leaders.
Pre-event setups and volatility premium. Earnings reports are the events that most commonly cause volatility premiums to spike. The key to these is to make sure the stocks are set up in your chosen direction five to seven days ahead of the earnings report. The premiums will usually peak out 48 to 24 hours prior to the reporting date. The goal is not to hold the options into the report. That is gambling, and you will lose many more times than win in those situations.
FDA decisions, panel meetings, and clinical trial results all rocket volatility premiums. Just make sure that you are getting in at least five to seven days ahead of the scheduled date, and sell one or two days before the event. The one thing to be extra careful with is biotech events, with the possibility of a stock halt ahead of the news release. This takes control completely out of your hands. This is why it is important to scale out of your positions 48 to 24 hours ahead of time. Always remember that you are not only selling the news, but selling right before the news.
Heavy options volume in favor of your position. If you are long calls, an explosion in call volume is always a good thing that adds to the volatility premium. If the calls outnumber puts at least three to one, that's even better. Remember, once again, this is all a facade, as you ultimately will want to lock profits into the height of optimism. Never believe the hype, especially if the hype turns out to be true. Always plan on cashing out 48 to 24 hours prior to the event.
EXAMPLE: GE July 13, 2009 Calls Trade
This is a real example of one of my personal options trades. In July of 2009, I played the GE July 13, 2009 calls. On July 13, 2009, I took 400 contracts at 0.02 before an earnings announcement on Thursday morning, July 17, 2009, while the stock was trading at 11.25. Friday, July 19, 2009 was an expiration Friday. The daily stochastics had a mini pup and GE was a laggard to the rest of the financials and banks. The daily upper Bollinger bands sat at 12.75 with triple resistances at 13 including a daily 200-period moving average, weekly upper Bollinger bands, and monthly resistance. The calls were technically worthless because they were almost 2 points out-of-the-money.
While a newbie will see this trade as a lottery ticket for GE earnings, the reality to me was that the daily chart was enough to expect a $1 move to the upside ahead of earnings. The delta on the calls was 10, which meant for every $1 move on GE, the calls would move 0.10. As it turned out, the markets grinded higher and GE ramped up to 12.50 before the earnings release on Thursday morning, one day before expiration Friday. I dumped out 399 contracts at an average price of 0.10 (from 0.08 up to 0.15) for a nice healthy profit, grossing around $2400 into buyers. The calls jacked up as high as 0.18! GE came out with earnings and they didn't do squat for the stock as the sell news reaction kicked in. Even though GE was trading down in the 12.30s, the calls were selling at 0.01 whereas the day before, they were trading at the same price.
In this trade, this is how I stacked my factors:
Laggard: GE was a laggard, as the rest of the financials were trading at or above their daily upper Bollinger bands. BAC, WFC, JPM, and GS were trading way above their daily upper Bollinger bands. In fact, GE was the only one that actually had yet to break back into an uptrend on the daily. The SPY was in breakout mode as the weekly formed a mini pup breakout and daily stochastics were crossing back up with a close above the daily 5 at 88.30. SPY eventually ramped to 96.
Daily Mini Pup: GE formed a daily mini pup. The weekly was in a make or-break, and the 11.47 level was the weekly 15-period moving average resistance that was the key break. All the aforementioned financial stocks had broken through their weekly 15-period moving averages.
Earnings Events: GE earnings were scheduled for the following Thursday morning, with options expiration on Friday. More important, the leading back stocks were coming out with earnings during the whole week, kicked off by GS on Tuesday. A lucky break was a GS upgrade out of the blue from super bear Meredith Whitney, which sent GS up +7 on Monday. These actually lifted volatility premiums on banks’ stocks across the board.
Call Volume: Call volume went through the roof, outnumbering put volume 3 to 1, especially in the out-of-the-money contracts.
All these stacked factors made for a pretty stress-free trade. The calls chopped around the 0.03 x 0.04 bid-ask spread until Tuesday. Then the volume skyrocketed over the next 2 days to peak out calls around 0.18 as GE peaked out near 12.70. I scaled out at 0.08, 0.10, 0.12, and the last contacts out at 0.15.
A stacked combination of components is what makes the options strategies appealing – creating leverage without typing up too much capital, and allowing you to trade other stocks in the meantime.
PLEASE READ: Auto-trading, or any broker or advisor-directed type of trading, is not supported or endorsed by TradeWins. For additional information on auto-trading, you may visit the SEC’s website: All About Auto-Trading, TradeWins does not recommend or refer subscribers to broker-dealers. You should perform your own due diligence with respect to satisfactory broker-dealers and whether to open a brokerage account. You should always consult with your own professional advisers regarding equities and options on equities trading.
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