Hello again, This week we will summarize another strategy for trading Options. PUTS, which are the exact opposite of CALLS. Options are considered more risky trades because of the time decay involved. They are however less expensive than buying underlying stock, so there is a little finesse involved with Options trading to be successful. We will review what an Option is then delve into PUTs. Options are the right to buy a stock at a certain price over a given time period. To find Option-able stocks in the IBD, look at the far right of the stock column under PE, to the right of the PE number you will see alphabetic letters, the small o stands for Option-able. Or look the stock up on Big Charts and click on Options Chain. Options are sold for a certain length of time and expire the third Friday of every month. As a general rule we buy an option for 90 days or longer. You can sell the option at any time, but you always want to sell before the third Friday of the month your option expires. In fact, you will want to sell a week or more before the Friday expiration. For an example, if you bought an option 90 days out to let s say March, you would want to sell a week or more before the Options Expiration date of that 3 rd Friday in March. Options are sold as contracts. There are 100 shares per contract. So when you look at the price of the option you want to buy, be sure and multiply that number by 100 so you will know what your investment (risk) will be for one contract, then decide if you want to buy more contracts. Because we only have a limited time for our option to profit given the time decay, we only want to trade about 20% or less of our trading account. Because of the volatility of an Option, we set our TSL at 50% otherwise we are kicked out too quickly. If you look at the GOOG (Google Inc.) stock above, that is $535.18 a share, and because the larger industries and financial institutions trade that stock, it becomes more volatile with the larger price moves. Look at the price bar lengths below.
Because we only want to buy the right or option to purchase the underlying stock, the option price is much less. In many cases, just pennies on the dollar. A little more with expensive stocks like GOOG. For our trading purposes, we do not want to exercise the right to buy the underlying stock. We are only interested in seeing our PUT Option make a profit and sell it. Not buying the underlying stock gives us a greater ROI (Return on Investment). There are many ways to trade Options, we instruct you on how to trade the two easiest strategies; Calls and Puts. We covered Calls now we will explain Puts. Puts are traded when the Fundamentals and Technicals meet the Shorting or Sell criteria. For Options we adjust our Big Charts Advance Charts settings to: SMA is now: 200,10,40 LOWER INDICATOR #2: Williams %R The rest remains the same. This chart is a little faster than the stock trading setting because the Options are more volatile and we are trading against time. As for knowing when to get into a Option Put, we look for basically the same indicators as a Short. Price bar closes below the 10 SMA, MACD crosses over to the downside and sell volume is rising. But we have a new indicator now to watch and that is the Williams % R. Williams %R indicates whether a stock is overbought or oversold. For a PUT, we want between 0% - 20% overbought, or off the top. Think of it this way if a stock is overbought, what has happened to the price? It has risen right? What s going to happen next? Investors are going to take advantage of the higher price, sell their shares to take profit and drive the price back down. Buy low, sell high. Looking at GOOG s William %R, we would say the stock is kind of in the middle not overbought (0-20%) and not oversold (80%-100%).
When the stock meets all of our criteria for a PUT, we then click the Options Chain to look at our PUT opportunities. We get a very large graph in different shades of gray or blue, depending on what platform you are using, we use Big Charts as a common denominator, that way everyone is on the same page for instruction purposes. And at the bottom of the graph is a list of months. Those months are how far out you can buy your Option, in this case a PUT. Time is money, the more time you buy the more expensive the Option since you are reducing your risk. As a new student buying our first PUT (Virtual trade!!!!) We want to buy between 5 and 10 contracts being careful not to spend more than 20% of our trading account. If we buy less, then we stand to lose profit as it gets eaten up by broker s fees. We are going to switch to some lesser priced stocks for demonstration purposes since GOOG is a hefty stock traded mostly by Day Traders. Let s examine UA (Under Armour Inc.)
If you examine the chart above you can see where the Williams %R started coming off the top at the 0% to 20% range, the next signal you will see will be the price bar closing below the 10 SMA. They usually follow in this sequence, and then you will see the MACD Crossover and the Sell Volume increasing. This was a perfect set up and happened around the 25 th or so of September. So let s say all the stars aligned for UA now as they did back around September 25th (for demonstration purposes only folks, this is not a recommended trade) and we ll look at the Options Chain for UA.
As you can see towards the top of the Chart, we have circled the PUT side in Green, the current stock price is the red boxed area in the middle and we want to go out at least 3 months. In this case, January. When considering where to buy our PUT, we must look at the OPEN INTEREST (OI) to the far right of the STRIKE PRICE COLUMN. We only want to buy Options with an Open Interest of 100 or higher. Anything less and we may not be able to sell our position before expiration. So let s look at January. January buys us a lot of time, if you look at the chart below, you will see where I highlighted Open Interest in yellow and it varies so we are only interested in OI of 100 or better.
As you can see the dark blue square is the actual price of the stock at the time you are viewing the chart. The numbers above and below it are the directions in which the stock can head depending on the indicators and outside influences. When buying a PUT, we expect the price of the stock to go down so we want to seethe stock at a higher price and trending lower which will increase the value of the PUT Option. With UA, the stock did reach a 6 month low of 53 and a 52 week range of 44.07 to 82.95. By looking at the SMA chart, there s really no way to tell how low the stock may go so we play it safe and buy one OUT OF THE MONEY. On the January Chain above that would be at the 65.00 Strike Price. It has an open interest of 285 so there is enough interest that we should be able to sell our position. Now, how many contracts are we going to buy and what will be our total risk? Let s look at the January Chain.
So looking at our PUT side, I X d out the CALL side, we see our 1 out of the money is 65.00 circled in green, our open interest is 285 circled in green and our Bid price is $9.40 X 100 shares in a contract would equal $940.00 for the Option to buy the stock versus $6557.00 if we were actually going to purchase the shares. The Ask price is what the Broker would like to get for the Option rights but like on EBay, you bid to get the lower price. Bid increments can be just pennies but are usually five to ten cents. The question now becomes, how do we figure how much profit we stand to gain? It s hard to tell but a quick way to Ball Park it, is to look at One In The Money. The circled 10.70 is one in the money, the arrowed 9.40 is what we paid. The difference between the two is a rough estimate of what we can expect as a profit. In this case 10.70 minus 9.40 is a profit of 1.30 times 100 shares would be 130 dollars or a 13% ROI on a very conservative trade. Not a bad return on a relatively safe trade. Our TSL is set for 50% so had the trade turned against us, right out of the gate we would have been kicked out with a $4.70 loss or $470.00. Looking at the chain above again, if we had chosen the second highest OI of 186, our bid would have been $3.80 ($380.00 for one contract) and our profit would be 10.70 minus 3.80 equaling 6.90 if the stock hit the $50.00 Strike Price with an ROI of 181%. Knowing that we can sell at any point, we don t have to wait until it reaches the 50 if it looks as though the sell signals are showing on the technicals. The sell signals are the same pretty much as they are on a Short Sell only we are watching the Williams % R as it generally is the first signal before the close (Above
the 10 SMA) on the price bar. The sell signals for the Williams %R will be coming off the bottom in the 80% to 100% indicating it is oversold now, the price bar closes Above the 10 SMA, the MACD crosses to the upside and the Buy Volume rises. Looking at UA again the blue circled area shows where the sell signals may be emerging for selling the PUT as the Williams % R appears to be coming off the bottom BUT there are no other sell signals. There is no daily bar closing above the 10SMA, there is no MACD crossover to the upside and there is no increased buy volume.
Moreover, Earnings is October 25 th, and the chart was captured on October 3 rd. What is our rule about Earnings? Never ever hold a stock/option through earnings. So in this case we would not even buy the PUT option until after Earnings on the 25 th. Will UA still meet all the criteria for a PUT after the 25 th? We ll have to wait and see. So what are the actual steps to buying and selling a PUT once we have decided to take the plunge? To buy the PUT you will choose One in the Money or One Out of the Money depending on your budget, and click on it (depending on which broker you are using) it should ask if you want to buy that Option. Click on YES, you will BUY TO OPEN, use a LIMIT ORDER and GOOD UNTIL CANCELLED, not all Options Brokers offer TSL s so if they don t, you will have to use alerts and be vigilant in watching your trade. Next you print your confirmation and note your Trader s Log. If your TSL does not stop you out and you wish to sell at any point, you will SELL TO CLOSE print the confirmation and be sure your account is credited. Note Trader s Log and shred receipts (after you are sure your account has been credited.) As a newby you still do not want to hold an Option through Earnings. If you have bought a PUT and Earning is before your expiration date, you will want to sell the first profit chance you get. As you season with experience you will learn to read and understand the GUIDANCE of a stock before Earnings to know whether or not you want to risk a small position and hold through Earnings. This is a way to supercharge your returns but ONLY after you have had quite a bit of virtual experience. Holding through Earnings is very risky business. So Let s recap on a PUT transaction: 1. Choose an Option-able Stock off your watch list 2. Reset your Big Charts for 200,10,40 SMA and Williams %R & save settings 3. Watch chart indicators Williams % R between 0% and 20% coming off the top, price bar closes below the 10 SMA, MACD Crossover to the downside, Sell Volume rising. 4. Go to Options Chain, choose One in or Out of the Money with an Open Interest of 100 or better 3 months out. 5. Look for Earnings Date and make a note on calendar. 6. Buy to Open, Limit Order, Good Until Cancelled, print confirmation and note Trader s Log. 7. Set TSL 50% Order or Alert if broker does not have TSL for Options. Print Confirmation and note Trader s Log. 8. Check chart daily, morning or evening which ever suits your schedule. 9. Watch for sell signals, Williams %R coming off the bottom between 80% to 100%, price bar closes above the 10 SMA, MACD Crosses to the upside and Buy Volume rises. 10. Sell to Close, print confirmation, be sure money is credited to your account, note Trader s Log. Once money is in your account, shred your receipts. As always, please review the course video as often as you need. Please call us if you have any questions. Series 10 will cover Psychology of Trading.