In Options 101, I used the example of XYZ stock. In that example I showed how using options could garner a huge profit and return on investment. How are these awesome trades found? Those are the types of trades the internet gurus use to try to sell you their $5,000 options course. But in reality this is what happens so many times:
- XYZ did invent a cancer drug causing the rumor but they didn’t get FDA approval and I watched my investment shrivel like holding an ice cube on a summer day.
- XYZ didn’t meet the market makers earnings expectations and the stock went down below $200 instead of up. My investment $10,000 went to $0.
When buying options these things have to happen in order to profit:
- I have to have the right stock. Finding the stock that is poised for a big move out of the 8000+ traded daily, takes research, knowledge and a little luck.
- My timing of when the stock will make its move has to be perfect.
- The stock has to move in my direction significantly and in a relative short period of time
In my opinion these are reasons why many stock brokers and “financial advisors” will tell you investing in options is dangerous. If the proper education and caution are not utilized, that is good advice.
Loving the Melting Ice Cube
There is a flip side to every coin. How do I use the melting ice cube to my advantage? If the melting effect is dangerous in buying options, maybe it’s advantageous in selling options. Can I do that?
If I sell an option or stock to the market (selling short), I am selling something I do not own. My hope is that I can buy that option or stock back at a lower price (covering the trade), fulfilling my obligation to the market and thereby profiting from the difference. In order to do this type of trade, my broker will insist I have a required amount of money in my account known as margin.
When buying options I, win if the price goes up significantly in a favorable amount of time.
When selling options I win if the price goes down or doesn’t move significantly. Selling options gives us 2 opportunities out of the 3 possible market actions to profit.
This will be covered more thoroughly in another lesson.
Finding the Trades
I said in Options 101 that analyzing stocks can be a daunting task and for that reason I don’t do it. But I do utilize the information my software program gives me. It will do the things I am unwilling to do and have no desire to learn how to do. This is how my sort works:
- I have all the stocks that trade in weekly options in a watch list. This narrows the field down from 8000+ to 400+. This list is consistently growing. These stocks are the best of the best in my opinion.
- One of my sort parameters is to find stocks that a 10 day moving average is at its 3 month high.
- Another is that a 65 day moving average is at its 3 month high.
- These two parameters guarantee the stock is in both a long term and a midterm up trend.
- It also sorts out stock that the 40 day moving average of a timing indicator is at a 3 month high.
- My final parameter sorts stocks that meet these qualifications and are priced between $50 and $150.
I do this sort on a Monday morning about 1 hour after the market opens. Once the screen parameters are set (a one-time event) the scan can be done in a minute or 2. This produces from 8 to 10 stocks.
I then run a check to see if there are any major events such as an earnings report, a major law suit, a takeover or scandal of any kind pending or coming up in the near future. Those stock are eliminated. This procedure takes maybe 10 minutes.
The remaining stocks are transferred to the charting program with the click of the mouse. With a little practice the charts will start “talking to you”. Although all the charts should show the stocks are all in a nice up trend, on or two of them will show a recent divergence to that trend. These are the stocks that are my candidates for my weekly trade and the ones that will provide me with my Friday paycheck.
So far I have spent maybe 10 to 12 minutes in the process.
The next phase will take the longest to perform and will be covered in