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Researching Trade Candidates

My analysis of the Underlying Asset (ULA)

{previous steps}

  1. Identify the financial asset 
  2. Pick “underlying” asset to trade (using a stock screener, analysis, or using third-party research).
  1. Formulate your investment objective.
    1. Is it to speculate on a bullish or bearish view of the underlying asset?
    2. Is it to hedge potential downside risk on a stock in which you have a significant position?
    3. Are you putting on the trade to earn premium income?

Core Strategy aka ‘the Charts’: What you see is what you get (WYSIWYG)!

The 8-step process before and after every Trade
1. CORE STRATEGY, ‘The Charts’
2. CORE STRATEGY, ‘Quality control and scoring’
3. STRATEGY SELECTION
4. STRIKE SELECTION
5. STRATEGY CONFIRMATION
6. REWARD/RISK GRAPH
7. POSITION SIZE
8. PLACE ORDER
During the Trade
MANAGE TRADE
MONITOR REPORTS
After the Trade
LOG TRADE

First step: study the underlying charts, then decide whether I will go long or short.

Core Strategy for Chart analysis

Step 1 -Curve

step 2 – Zone

Step 3- Trend

Core Strategy for ‘qualifying, scoring and setup a trade candidate

step 4- Score

Step 5- S.E.T.

If I go long, I will buy Call.
If I go short, I will buy put.

How to study Option Chain because it will tell you
1. Open Interest (OI) at every strike – this number means how many bets are placed by sellers and buyers on crossing a particular strike
2. Prices of Options, IV and other parameters.
The first detail, which is Open interest at every strike is the most important part of the Option Chain. What Open Interest at a Strike Mean, when there is a huge OI at a strike, say 11000, there are two things it conveys
a. A bunch of buyers are betting it will cross that strike
b. A bunch of sellers are selling it will not cross that strike
c. Options sellers are usually big players like institutions, and Options buyers are generally small players like retail investors
d. Retail usually gets it wrong, because of their own psychological biases etc.
e. Therefore, when there is a huge OI on a strike, it is a seller’s bet that it will not cross that strike. Which means a huge Put OI is a support and a huge call OI is a resistance
CAUTION:
Do not trade base on these numbers only. These numbers have no meaning in illiquid options and can show wrong values. Please do not trade illiquid options. Liquidity and reliability drop after this point. For this analysis to work, there must be significant OI build up. This can happen only in top liquid stocks 2-3 days after the previous expiry, giving it enough time to have OI build up in the new expiry.

STRATEGY SELECTION

I always buy ATM Options because it has delta value anywhere from .40 to .60

Delta (.40) means if underline stock price up 100 points, then the option I bought will go 40 points.

  1. Determine your risk-reward payoff.
  2. Check the Volatility.
    1. key factor in identifying your option trade/strategy: Compare the level of IV with the stock’s HV and the level of volatility in the broad market
    2. IV: whether other traders are expecting the stock to move a lot or not.
    3. High IV: Push up premiums, making writing an option more attractive, assuming the trader thinks volatility will not keep increasing (which could increase the chance of the option being exercised).
    4. Low IV:   Cheaper option premiums, which is good for buying options if underlying stock will move enough to put the option in (further in ITM).
  1. Identify events.
    1. Market-wide: Federal Reserve announcements and economic data releases.
    2. Stock-specific: Earnings reports, product launches, and spinoffs.

EARNING REPORT: XYZ Earnings (Beats /or DOWN) Estimates (Date)

XYZ reported earnings on (July 13, 2018), before the market opened. Earnings Per Share (EPS) was reported at $1.63, after analysts had expected $1.57 per share. Despite the results, XYZ opened down -0.8%, and closed for the day down -2.2% at 67.00. Since earnings were reported, the stock has traded in a range from 66.22 to 68.30.

Price Volatility Against Expectations

Ahead of earnings, option traders were expecting a ± 2.3% move for this date, so the earnings move of -2.2% was right in line with expectation. XYZ has only experienced 4 larger-than-expected earnings moves in the last 12 quarters.

Earnings Option Strategies

Market Chameleon’s option strategy analysis shows that selling out-of-the-money puts one day after earnings and buying them back one week after earnings had 83% winning occurrences, for an average gain of +60.6%. Additionally, selling at-the-money straddles resulted in 50% winning occurrences, for an average return of +9.2%.

STRIKE SELECTION

ExampleStock PriceStrike Price RuleInterval Typical Strike Prices
 $20<S25$2.50$15, $17.60, $20, $22.60
 $57$26 to $200$5$45, $50, $55, $60
 $300>S200$10$280, $290, $300, $310
Strike price table

Stock Price to Strike Price Relationship

The option contract’s strike/exercise price stays same, but stock price fluctuates daily.

Money-ness means if you exercise your option now you will be out-of-money (loss), or in-the money (Profit) or at-the money(breakeven). As an options trader we aren’t concerned with exercising options (we just buy and sell them)

My strategy selection will determine if you pick an ITM, ATM, or an OTM option

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