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Option Investing

Options are the most adaptable trading instruments available to investors and are a great way to make additional income. Options trading costs less that stock trading and option investing provides a high leverage approach to trading that can drastically limit the overall risk of a trade.  To trade options means that there is a contract between two parties regarding the price direction of a particular share. One party believes the price is going to fall within a certain time and the other party believes that the price will rise during that time. The party trading options will either buy or sell the option, depending on the direction they believe the price will turn. Option investing gives the right to a person to buy an option, with no obligation to buy or sell a set number of shares, also at a pre-determined price on or before a set date in the future.

In order to trade in the options markets, there is terminology that you must be familiar with. The “strike price” is the price at which an underlying stock can be purchased or sold if the option is exercised. There are several strike prices available that are above and below the current price of the underlying asset. The “premium” refers to the price on an option when option investing.  The strike price, the time remaining until the option expires, the option volatility, and many other factors, determine the premium. When option investing, you must also know that each option on a stock corresponds to 100 shares.  When conducting online options trading, you also must know that there are two types of options. There is a “call” option that gives the owner the right to buy shares, and there is a “put” option that gives the owner the right to sell shares. 

Option investing also follows a cycle that contains a four-month interval as well as three fixed expiration cycles.  Stock options expire by the close of business on the 3rd Friday of each expiration month and each stock has a corresponding cycle of months that they offer options in. How it works is that all listed options are available for the current month and the following month and additionally for specified future months. The four month cycles for online option trading are the following:

 1)  January, April, July, and October
 2)  February, May, August, and November
 3)  March, June, September, and December

Option investing is a little more complicated than shares when investors begin their option trading education.  After some practice successful traders realize that they are able to generate a nice monthly income and they can assure their portfolio. They realize as well that they are also able to get a return on investment equaling 100% or more on successful trades. It is also important that you take that extra step and trade creatively!  Creativity in option investing is a winning characteristic that is rare in this market. If you can learn how to trade option effectively and show creativity in your trades, then you are already a step ahead of the next guy!


Market Direction - Candlestick signals produce expected results with a fairly high degree of probability. Candlestick patterns produce expected results with a fairly high degree of probability. Knowing the difference patterns allows an investor to be prepared for the next possible patterns set-up. This is currently occurring in the Dow. The Dumpling Top that formed over the summer had an expected result. A strong downtrend! This now sets up the possibility of the next price pattern. Whereas the Fry Pan bottom pattern, the opposite of the Dumpling Top pattern, has the expected result of a very strong bullish price move. Once this has occurred, what is expected next? Either a reversal of the trend or some profit-taking. This now becomes the set up for a possible J-hook pattern. The prerequisite for a bullish J-hook pattern is an initial strong price move.

The Dumpling Top creates a strong down move. A bounce can then be expected after the strong down move. This creates the possibility of a bearish J-hook pattern. The scenario becomes more likely when one of our predominant indicators appears to be acting as resistance. The T-line seems to be the resistance level. As can be seen in the Dow chart, the initial reversal failed at the T-line. The next bullish attempt also failed at the T. line. With stochastics starting to curl back down, simple visual assessment identifies the possibility of a J-hook pattern formation. Being able to visually recognize the next patterns set-up, after witnessing the elements that make for that next pattern, allows investors to take advantage of expected results.

The Dow is now on the verge of breaking down again. As candlestick analysis often refers, the longer a downtrend persists, the greater the possibility of witnessing panic selling. The next wave of the downtrend has three facets that could make it move fairly rapidly. Hedge funds are in the process of liquidating due to redemptions. This creates more selling pressure. That selling pressure instigates more margin calls. One of the basic rules of investing is to never cover a margin call. The reason the margin call is in existence is due to the positions in the account not doing what they are supposed to. That should be the first inclination to close out the positions. However, what is the thought process for most investors that are receiving margin calls? "I would hate to sell out here knowing we're probably pretty close to a bottom." Most investors will put off doing anything until they are forced to liquidate positions. That means they will hold on as long as possible waiting for prices to improve, thus eliminating the margin call. Unfortunately, when selling pressures continue to move prices down, it creates a snowball effect. More accounts start receiving margin calls. The downward spiral of prices pick up steam as investors start liquidating the minimal amounts required to cover the margin calls. This pushes prices lower, creating more downside pressure. At some point, the diminished equity of the accounts require the brokerage firms to start mandating positions be liquidated. Along with panic selling coming into play, the continuing selling pressure eventually has investors having to sell at any price.

DOW

This creates the classic capitulation day. It can usually be identified when prices start crashing down, causing inordinately large reductions in prices. Usually buyers know enough to step out of the way until some sort of bottom equilibrium is finally reached. This provides the opportunities to produce huge profits for the patient investor. Stock prices can drop 20%, 40%, 60 %, or greater in a matter of minutes. When these types of price moves can be readily seen across many stocks, that should alert investors to be prepared to buy once the bottom is hit. How do you tell when the bottom is hit? Knowing that this type of day could occur, and seeing prices drop rapidly, pulling up the one minute and five minute charts will make it visually clear when the Bulls and the Bears have reached equilibrium. Dojis, hammers, bullish engulfing signals will all start showing up on the short-term charts. That immediately tells you that the Bulls have found a level where they want to start stepping in.

Capitulation days do not occur very often. We saw one two weeks ago at the end of wave one. The Dow moved down over 500 points in the first 30 minutes of trading. Stocks were gapping down. This was the time to buy. The Japanese rice traders say when you see prices gap down in oversold conditions, start looking for candlestick buy signals. It is not difficult to anticipate what was going on that day by knowing simple candlestick analysis rules. Be ready to take advantage of the next capitulation day where prices may become dramatically discounted, producing huge profits in just two or three days. This is not heavy analysis. This is merely being able to use the information provided by candlestick signals and formations to be mentally prepared to buy when everybody else is panic selling.

Members' Chat session tonight at 8 PM ET.

Good investing,

The Candlestick Forum Team


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