DISCLAIMER: Stock, forex, futures, and options trading is not appropriate for everyone. There is a substantial risk of loss associated with trading these markets. Losses can and will occur. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representation or implication is being made that using the information in this special report will generate profits or ensure freedom from losses. Risks also include, but are not limited to, the potential for changing political and/or economic conditions that may substantially affect the price and/or liquidity of a market. The impact of seasonal and geopolitical events is already factored into market prices. Under certain conditions you may find it impossible to liquidate a position. This can occur, for example, when a market becomes illiquid. The placement of contingent orders by you, such as stop-loss or stop-limit orders will not necessarily limit or prevent losses because market conditions may make it impossible to execute such orders. In no event should the content of this correspondence be construed as an express or implied promise or guarantee that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Information contained in this correspondence is intended for informational purposes only and was obtained from sources believed to be reliable. Information is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted. Copyright by Profits Run, Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic, or mechanical, including photocopying, recording, or by any information storage and retrieval system. Published by: Profits Run, Inc. 28339 Beck Rd Unit F1 Wixom, MI 48393 www.profitsrun.com
Objectives: Understand the Options Income Engine, including identify set up conditions, when to enter a trade, how to set initial stop and trailing stop orders, and how to exit a trade profitably. www.optionsincomeengine.com Page 3
Trading Strategy. Well, we re going to be using daily candlestick charts for analysis. We are swing trading minor trends of a week to several weeks within a major trend. We ll use only four common technical indicators, together with uncommon trading tactics. Now, conventional wisdom is the opposite; that is, to use a wide array of indicators with commonly used trading tactics. Conventional wisdom, however, simply does not work. We re going to be buying on weakness into support in an uptrend, and selling short on weakness and support breaks in a downtrend. So two different approaches because the markets act differently in a bear market than they do in a bull market. www.optionsincomeengine.com Page 4
We re going to minimize the initial risk in the trade and then scale out of a position profitably with the two-step exit strategy. We re going to trade only options on those stocks and ETFs that trade in a deliberate fashion most of the time. Only enter the market after all the setup conditions have been met, and it is not earnings announcement week. We re going to select the best option for each trade; determine your position size based on the risk management rules. www.optionsincomeengine.com Page 5
Protect every position with a strategically placed stop loss order, based on the movement of the underlying stock or ETF. And so while our maximum possible loss on any given trade is the amount or the debt we pay for the option, even when a trade goes against us we do not expect to lose that entire amount. Further reducing the risk in the trade, we re going to exit half position at a strategically based profit target and protect the remaining half position with a trailing stop, allowing your profits to run as far as the market wants to go. Now if you re still in an open trade on the first trading day of the option expiration month, you want to roll to the next month that meets the option selection criteria, at the same strike price as the open position. www.optionsincomeengine.com Page 6
Okay, trading rule basics. The trading rules are segmented in four steps: specific set up conditions, specific entry rules, specific initial stop rules, and specific exit strategy rules. www.optionsincomeengine.com Page 7
Okay, first the uptrend set up conditions. We have four conditions, A, B, C and D. A the lowest close of the last five days must be greater than the moving average of the last 50 days, or that s the simple 50-day moving average at the lowest close day, and this will become more clear as we look at the examples. Condition B, the highest high of the last 16 days is equal to the highest tide of the last 30 days, meaning the high occurs on the same bar. Condition C, the stochastics percent K with an 8-3 setting is less than 25. In D, the OBV, or the on-balance volume indicator, is greater than it was 30 trading days earlier www.optionsincomeengine.com Page 8
Alright, let s now apply the long set up conditions to stock symbol FB, Facebook. Now, in all of these trade examples that I ll be reviewing with you, I m using charts complements of Trade Navigator, charting software by Genesis. It s excellent charting software, and here is the set up day we re going to validate; this red candle right here. Alright, so condition A is the lowest close in the last five days from set up. Day one, two, three, four, five, which would be right there on set up day in this case, has to be greater than the 50-day moving average in red, as of that lowest close day, and you can see it just barely makes it, but it does make it. If it closes below the 50-day moving average, it s a less reliable trade and we d rather pass on it. So B, the highest high of the last 16 days from set up day -- one, two, three, four, five and so on -- is right here, and if you count 30 days back, this is also that same high so this condition has been met. www.optionsincomeengine.com Page 9
Now, if we get too far away from the high in the market before we see a set up occur, then we don t want that set up because that market is probably now lost its upward momentum, so this set up has got to occur within 16 days of the new high. That s what that s all about, and in here, it occurred one, two, three, four about four days within that window, so that s ideal. Now at the same time, condition C, the percent case stochastics with an 8-3 setting -- that s the blue line here -- has to be less than 25. That indicates the market is what s called over sold in an upward trend, suggesting that it wants to bounce from that point. And then condition D is the on-balance volume. It s greater than it was 30 days earlier, so we don t care about the absolute value of the on balance volume but only the trend, and at this point here, it is indeed higher than it was 30 trading days earlier. So the trend is up, and that s what we re looking for; that s a great confirming indicator. Now, the percent D on the stochastics is commonly plotted along with the K, but we re not using the D. The D is just an average of the K. It s a three day average of the K, the blue line. We won t be using that here. We re just focused on the percent K, itself. Okay, so all the set up conditions have been met, making this a valid set up day. www.optionsincomeengine.com Page 10
Okay. Let s apply the long set up conditions now to USO. This United States Oil Fund ETF. Okay, so here s the set up day we re going to validate, right here. And so, first, the lowest close of the last five days has got to be greater than the moving average, based on 50 days at the lowest close day, and you can see that s easily met here. Here s the close. Right there s the lowest close, and here is the 50-day moving average. So we re good to go there, and condition B, the highest high of the last 16 days, remember we need this entry point to be within 16 days of that high, so here it is -- one, two, three, four, five, six or so days, no problem -- where that highest high, in the last 16 days, has to equal the highest high of the last 30. So whether you count back 16 this way or 30, you ll see that this is indeed the highest high of both the last 16 days and the last 30 days. And then condition C, this stochastics percent K, based on an 8-3 setting, is less than 25, and the unbalanced volume is greater than it was 30 trading days ago. Meaning what? That it s trending up. So all the conditions have been met, making this a valid set up day. www.optionsincomeengine.com Page 11
Uptrend entry rules. Once a set up day occurs, we can consider placing an order for the following day to buy as follows: Buy a one or two strike in the money call option, with 60 to 90 days until expiration at the market on the open. With this order, we re buying into a strong uptrend after a nearterm correction. www.optionsincomeengine.com Page 12
Okay, the long entry rules, applying that to our FB example. Here was our set up day, and now here s our entry day. We re going to simply buy to open a September 60 call at the market at 540, $5.40. Now when we re placing this trade, we re in the month of July. This is the month of July in this example, so we re one to two months out. The September option is what we re selecting. We re selecting the 60 strike because Facebook, at this point, is trading around 64, so we re one or two strikes in the money, and we ve got an open interest that s greater than 100. www.optionsincomeengine.com Page 13
And applying the long entry rules to our USO example, here s our set up day. Now we re going to buy to open the June 79 call at the market, which is $1.80, at that point, and the month of this trade is March. That s why we re selecting the June call. The price of USO is around $81, at that point, so we re selecting the two strike in the money, 79 June call. Open interest is greater than 100. www.optionsincomeengine.com Page 14
Uptrend initial stop. Now once filled on the entry order, enter the initial stop order as a contingent order as follows: If the stock trades at less than the set up day close minus the ATR 20, as of the set up day, times five, then sell the call option to close at the market. www.optionsincomeengine.com Page 15
Applying the initial stop to our Facebook example, here s our set up day; our entry day, our entry level right in here, and we re going to take the set up day close right there, pick off the ATR, as of the set up day close, times five. Subtract that from the set up day close, and we get a price of $54.83, which is off the charts, well down in the chart. Now you might ask (you stock traders) why would you play such a wide stop? Well, this is where the power of options trading comes into play. We re buying this call for $5.40, controlling 100 shares of Netflix for only $540. Whereas if you bought the stock, would require $6,400. Now because this is the most you could possibly lose on this trade, and because you re already applying risk management principals to be sure that this is not more than two to five percent of your account, depending on your account size, you can give this market a wide berth. You can give it a lot of room for you to be right, because after all, you have all the way into the month of September from the month of July here to be right. www.optionsincomeengine.com Page 16
Now if the market, instead of going up the way it did, if it had traded down for several days, and I mean way down. Let s say it traded down five percent, six, seven, eight percent, your maximum possible loss is 540. And even at that point, if it s down five, six, seven percent, the call option is still going to be worth probably $2.70. Now then, remember we re in an uptrend, as indicted by the 50-day moving average, and so even if the market sells off like this as it sometimes does, it will recover, and it will hit your profit targets and turn into a very nice profitable trade. Whereas, if you were to buy the stock here, you would be forced to place a stop fairly tightly, right in here. Why? Because as soon as the market falls below that level, your stock position is going to start losing a lot of money, and so you can't stand that. But when you do that, your percentage of winners goes down, and that s why these options are so great; you minimize your risk right out of the shoot. If the market went to zero somehow overnight, the most you could ever lose is $540 per option, and you give yourself time to be right, and consequently, the percentage of winning trades is much higher than it would otherwise be trading the stock. www.optionsincomeengine.com Page 17
Applying the long initial stop now, to the USO example: Here was our set up day, our entry day where we bought to open the June 79 call, at the market $1.80, and our initial stop, stock set up day close. Here is the set up day close, right here, minus the ATR 20 as of set up day, times five. That takes you down to 6751, so it s actually off the chart a bit. Again, an initial wide stop because time is on our side if the market wants to head lower first before going up -- remember, the major trend is still up -- then that s okay because time is on our side and we want to give it that leeway if that s what it wants to do. As soon as it does start moving favorably, though, we re going to move that stop from down here all the way up to a profitable level, locking in profit. Okay, so let s summarize those concepts: Since we have limited risk when trading options, and we re trading options with 60 to 90 days until expiration, we have a great advantage over stock traders in that we have plenty of time for the trade to become profitable without having to use the normal tight stops that you would use when trading stocks. www.optionsincomeengine.com Page 18
Following this wider initial stop strategy enables a very high percentage of winning trades without taking excessive risk. Now, if and when the initial stop is hit, an alternative strategy would be to not sell to close the position if the call option has little value at that point, and instead just hold the position into expiration, giving it even more time to become profitable. If the market does not recover by expiration, the call option will expire worthless, and you ll be out of the trade. So this would be an alternative for a market that really traded down hard after your initial entry. But most of the time when we get stopped out, we ll be stopped out and still be able to recover a reasonable portion of the option premium. Now just a general comment on stops that applies to options or stock trading that you just need to understand not only intellectually but emotionally because no one likes a losing trade. But that comes with the territory and it really doesn t matter, especially with options where your risk is strictly limited and you expect to be a net winner over a series trades with a high percentage of winning trades. www.optionsincomeengine.com Page 19
However, just keep this in mind: If the stops hit we ll be stopped out with a relatively small loss. When this happens, the premise: the trade is over with because we re expecting the market to move favorably, and if it doesn t and our stop price is hit, then we re out. We know, going into the trade, the planned risk. We ll have the confidence and discipline to place the trade because of that, and we can always re-enter the position if the trading rules provide another set up opportunity. Otherwise, we want to look elsewhere. It s that simple. Uptrend trailing stop: if the lowest low of the last five days times 0.995 is greater than the set up day close, and if the low is less than the lowest low of the last five days times 0.995, then sell to close half position call option, at the market, or the entire position if the profit target has not been hit. Now, this is a fairly wide trailing stop that will consistently reduce the risk in the trade and begin to lock in profits, but at the same time, giving the market enough room to move against the position without getting stopped out prematurely. www.optionsincomeengine.com Page 20
And since we have more time with our call trade from a risk perspective than if we were trading the underlying security, using wider trailing stops allows us to capture dramatic double and triple digit gains with our option s position. So applying the long trailing stop to our Facebook example, here was our set up day, our entry day, where we bought to open a September 60 call, at the market $5.40. Alright, now, as soon as the lowest low of the last five days times 0.995 is greater than the set up day close: Here s the set up day close, and at the close of this day right here, we count back five days, one, two, three, four, five, that s the lowest low of the last five days times 0.995, and that is indeed greater than the set up day close. So at that point right here, is when we first move the initial stop, which remember was down here at $54 or so, giving us a wide stop to begin with, we move that stop all the way up to this level. www.optionsincomeengine.com Page 21
Initially we want to give it room if it goes down. But once the market starts moving as expected, we want to move that stop up dramatically, and that s what s happening here. So now we went from a wide stop to a relatively tight stop and indeed one where, if that stop were hit, we d exit the market with a small profit. Now then as the trade matures, we re going to keep moving the stop up, so at the close of this green candle -- one, two, three, four, five, we re going to move the stop up again, locking in more profit. The close of this candle -- one, two, three, four, five, we re moving it up again, and that stop stays in place until we get to this candle here. One, two, three, four, five, then we move it up again. Next candle, we move it up again. Okay, so we re always moving that stop up, based on the lowest low of the last five bars, and eventually this candle here one, two, three, four, five, we move it up again, and we get stopped out right here. Now, so we re selling to close half of the position at that point, if the profit target has already been hit. If the profit target has not been hit, we close out the entire position, and in this case you would have sold to close the September 60 call at $13.80. Now you re selling it at the market, but in this example that would have given you a price of $13.80. Again, triple digit gains from your entry price of $5.40. www.optionsincomeengine.com Page 22
And applying the long, trailing stop to USO example, here was our set up day, our entry day. We bought to open the June 79 call at $1.80, and now the stop is lowest low, five times 0.995, if it s greater than the set up day close. So let s check it out. Here s the set up day close, right here, and the first time this occurs is right here. Why is that? Because on the close of this candle, we count back five one, two, three, four, five. That s the lowest low of the last five, and it is greater than the set up day close, so we move the stop from well under the entry price to above the entry price, locking in at least a small gain. And then after each day closes: we count back five and just keep raising that stop. Let the market go as far as it wants to go, and finally we get stopped out right in here. Where we would sell to close the entire position: if the profit target for the other half had not been hit, but if it had been hit, we sell to close the remaining half position, at the market, and in this case the option price would have been at $13. Look at the gain on that trade. www.optionsincomeengine.com Page 23
Now this is the advantage of selecting the best of the best ETFs and stocks, those that have a tendency to move more than the general market, those that are deliberately trading, and of course those that meet all of the set up conditions. Uptrend profit target: Okay, this is part of our two-step exit strategy to scale out in two steps. One is with the trailing stop, and the other is with a profit target, so we re going to sell to close half position at the option entry price, plus the ATR 20 as of set up day, times three, times 0.80 limit. Now why 0.80? Well, when the market has moved favorably by three times the ATR, the delta for that option is going to be around 0.80, and it s at that point we want to exit half the position, and take that money off the table and book that very nice profit. This strategy is aimed at selling a portion of the position into strength. As I just said, capturing a very nice, quick profit, reducing the position size to reduce risk, and at the same time remain in the trade, letting the profits run for the second half position. www.optionsincomeengine.com Page 24
Now if the underlying stock or ETF price moves favorably by three times the ATR 20, then the option will be deep in the money at that point with a delta of 80 or higher, allowing us to take great, quick profits. So I ve said it twice because I really want this concept to sink in. As the stock moves deeper in the money, the option delta will go up, which is exactly what we want to have happen, and when we get to three times ATR, we take half the money off the table. Okay. Applying the long profit target to our Facebook example. Here was our set up day entry day, buy to open the September 60 call, at the market, at $5.40, and here s our profit target right here. We re going to sell to close half position of the September 60 call at the option entry price, $5.40, plus the ATR 20 as of set up day, times three, times 0.8 with a limit order because we only want to exit this half position if we get our price: $9.20. We pick off the ATR as of set up day, right here, and then multiply that by three and then by.8. Now why do we do this? We don t know how far that market is going to run. www.optionsincomeengine.com Page 25
I mean, from here it could drop back on down, and if it did we d really want to be out of the trade. And so we want to take half off the table when the getting s good and if the market wants to keep running, fine. We ll let it run protected by the trailing stop. And over the long haul, over a series of trades this two-step approach is scaling out of trade profitably will maximize your profitability and smooth out the equity curve. Applying the law in profit target now to the USO example, set up day, entry day, buying to open the June 79 call at $1.80, and we re going to sell half position to close at the option entry price of $1.80, plus ATR 20, times three, times 0.80. Here s our ATR 20, right here, and we re going to use a limit order -- means we don t want to sell for less than $8 -- and that was hit right here, a very nice trade. Very quickly in a matter of a few days, taking half of the position off at a very nice gain from $1.80 to $8, and letting the second half run as far as it wants to go. www.optionsincomeengine.com Page 26
Okay. Now let s look at the downtrend set up conditions where, when these are met, we ll be buying put options. Now, these conditions are a bit more complex than for the uptrend because when a market is in a downtrend, you need to take particular care when entering the market. Because the downtrends -- if they re valid, if they re going to actually follow through or going to occur very quickly, and so you don t want to get involved prematurely in a downtrend; only when it s confirmed that the downtrend has further to go. So here we re going to use a filter. Right off the bat, condition A, where the moving average of the SPY -- that s the S&P 500 SPDR ETF, 200-day moving average -- is less than it was a day ago. In other words, it s got to be going down, and in condition B, the moving average X, which is the exponential moving average of the 50-day SPY, has to be less than the simple moving average of the 50-day SPY, as of yesterday, so both the 200 and the 50 SPY moving average has to be going down. www.optionsincomeengine.com Page 27
That s the macro filter. Now if that s the case, then the remaining conditions pertain to the individual stock or ETF that s under consideration. So condition C, the close of yesterday, that s what.1 means. Close of yesterday is greater than the lowest low, the last 10 days as of two days ago. And D, the close of today or set up day, is less than the lowest low of the last 10 days, as of yesterday, or one day ago. Condition E, the moving average 50 has got to be less than the moving average 50 of five days ago, times 0.997, and what that is about is eliminating set ups that would otherwise occur if the 50 day moving average was flat. You know, in that case it s just best to stand aside. Condition F, the close is less than the 50-day moving average. And G, the highest high the last 10 days, minus the close of set up day, divided by the close of set up day is less than 0.10. In other words, we want that range of the last 10 days to be fairly tight. And then H, the low has to be greater than the lowest low of the last 70 days as of yesterday. This will eliminate getting into a down trending market after most of the down move has already occurred. www.optionsincomeengine.com Page 28
Okay, so let s apply the short set of conditions A and B first to the SPY, the S&P 500, SPDR ETF. So condition A is that the moving average of this SPY, based on the last 200 days, is less than the 200-day moving average as of the day before. In other words it s got to be going down, and you can see here visually that it looks flat, but you can see it s actually going down at this set up day. This is the day we re testing right here. And in addition, condition B -- the exponential moving average of the 50-day SPY, which is in green -- has to be less than the simple moving average of the SPY 50 as of the day before. So you can see here that the green exponential 50 is less than the simple 50 in red the day before, so this is an important confirmation of the down trend, within the already down trending 200-day moving average. Now once we have this filter satisfied, we can go on and look at the other conditions that pertain to the specific stock or ETF that we re trading. If these are not satisfied, then we cannot make that trade. www.optionsincomeengine.com Page 29
Okay, now we re going to apply the remaining short set of conditions to an example for Home Depot. HD is the symbol. So we re going to pick it up with condition C, after having satisfied A and B on the SPY. And here s that same set up day that we re going to validate, so condition C, the close of yesterday, has be greater than the lowest low of the last 10 days as of two days ago. So here s the close of yesterday right here at the top of that green candle body, and that s got to be greater than the lowest low of the last 10 days as of this red candle. And that was one, two, three, four, five, six, seven, eight, nine, ten, so that was the red candle low right there. And then D -- the close of set up day has got to be less than the lowest low of the last 10 days as of the day before -- and you can see that indeed that close is lower than that green candle low, which was the lowest low of the last 10 days from a day earlier. Then condition E, the moving average based on 50 days has to be less than the moving average 50 days as of five days ago, so here compared to back here times 0.997. www.optionsincomeengine.com Page 30
Again, that helps filter out flat 50-day averages, and then F, the close has to be less than the 50-day moving average and that s easily the case here, 50-day being in red here. And the G, the highest high in the last 10 days from set up day, which is right here. Minus the close of set up day right here. That difference divided by the close has to be less than.10 or 10 percent. Because if it s greater than that the chances are too big of a move has already occurred. In condition H, the low of set up day has to be greater than the lowest low of the last 70 trading days as of the day before. If you were to go back and look at the last 70 bars on here, you would see that this condition is indeed met. So all conditions have been met, making this red candle a valid set up day. Downtrend entry rules: So once the setup day occurs we can consider placing an order for the following day to buy as follows: Buy a one or two strike in the money put option with 60 to 90 days until expiration at the market on the open. With this order, we re selling short via the put option into a strong downtrend on a break to new lows. www.optionsincomeengine.com Page 31
Applying the short entry rules now to our Home Depot example, here s our setup day, and here is our entry day, was going to BTO Aug 27.50 Put at the Market, which in this case would have been $2.20. Now this is the month of June, so were going out to the month of August and our strike price 27.50 has to be in the money, at that point Home Depot was trading around $26.00 so this is a Put now so we want the strike price to be above the current selling price of the stock and open interest is greater than 100. So for this example, now remember, we want the market to go down. www.optionsincomeengine.com Page 32
Downtrend initial and trailing stop 1. Once filled on the entry order, enter the initial stop order and update it daily, as a contingent order as follows: If the stock price close is greater than the highest high the last six days, as of one day ago, then sell the put option to close at the market. www.optionsincomeengine.com Page 33
So applying the short initial and trailing stop one to our Home Depot example, here s out setup day, our entry day, where we bought to open the August 27 and a half put at $2.20. So what are we going to do here now? When the stock price close is greater than the highest high of the last six days from one day ago, then we exit at the market. We sell to close at the market. So where is the highest high of the last six days as of setup day? Let s count. One, two, three, four, five, six, there it is right there. So our initial stop would be just above that high on a close only basis. So if the market closes above that high, the next day we get out on the open. Now, that stop remains in place and you notice it s tighter than the initial stop we used for the up-trending market where we re buying calls. Again, that s because the downtrending market, if it s going to go, we don t give it a lot of room. It s going to go pretty quickly, so we have a tighter initial stop here. Now, then, that stop will drop as we get lower six-day highs. So let s go from this day here, one, two, three, four, five, six, that s the highest high and it s lower than this highest high so now we re going to lower the stop. So we re reducing the risk in the trade. Then as of the close of this candle, one, two, three, four, five, six, this is the highest high and we lower the stop again reducing risk in the trade and so on, all the way down to this www.optionsincomeengine.com Page 34
level right here. Now, this stop is going to be overtaken by trailing stop two, as you ll see in a moment. But if this stop is hit in the meantime, you re going to exit the entire position by selling to close the put option at the market. Okay, let s take a minute and deep dive the logic behind the downtrend initial stop. It s the same as the logic for the uptrend initial stop. Since we have limited risk when trading options and we re trading options with 60 to 90 days until expiration, we have a great advantage over stock traders in that we have plenty of time for the trade to become profitable without having to use the normal tight stops you would use when trading stocks. Following this wider initial stop strategy enables a very high percentage of winning trades without taking excessive risk. However, with the put options in a downtrending market, the initial stop is not as wide as it is for the uptrend or call options, as I ve explained in the example. If and when the initial stop is hit, an alternative strategy would be to not sell to close the position if the put option has little value at that point and instead just hold the position to expiration giving it even more time to become profitable. If the market does not fall by expiration, the put option will expire worthless and you ll be out of the trade. This is less likely to happen than it would be in the case of the call option. Most of the time if the put www.optionsincomeengine.com Page 35
option initial stop is hit, it s best to just get out of the trade because the put option will not have lost as much value at that point as the call option could have, but it s something to keep an eye on. And then the general comment, again, is worth repeating because this gets to the psychology of trading. If the stop is hit, we ll be stopped out with a small loss. When this happens, the premise of the trade is over because we were expecting the trade to move favorably and, two, we know going into the trade the planned risk, three, we ll have the confidence and discipline to place the trade and, four, we can always reenter the position if the trading rules provide another setup opportunity. Otherwise, we just look elsewhere. www.optionsincomeengine.com Page 36
Downtrend trailing stop 2: If the highest high the last two days times 1.005 is less than the setup day close and if the high takes out, or is greater than the that highest high (2) times 1.005, then sell to close ½ position put option at the market or the entire position if the profit target has not been hit. Now this is a tighter trailing stop then what we are using for an uptrend call option trade but still wide enough to consistently reduce the risk in the trade and begin to lock in profits, but at the same time giving the market enough room to move against the position without getting stopped out prematurely. This is the case with a down trending market, where it is going to move quicker and more directly without backing and filling then is the case in an uptrend market. As soon as the Trailing Stop 2 comes into play it will supersede Trailing Stop 1 as it is a tighter stop. So this 1-2 Stop approach in a down trending market still allows us to capture dramatic double and triple digit gains with our options positions, but not being as patient with the market as we would be in an uptrend. www.optionsincomeengine.com Page 37
Applying the short trailing stop two now to our Home Depot example, here was our setup day, our entry day, where we bought to open the August 27.50 put at $2.20 as soon as the highest high of the last two days times 1.005 is less than the setup day close, right there. That occurred right here for the first time. That s when trailing stop two supersedes trailing stop one and then every day when the market closes, count back two. One, two, lower it again. One, two, lower it again. One, two, lower it again. You keep doing that until you re stopped out, meaning you re going to sell to close half position of the August 27.50 put at the market. In this case, the option price at the market was $5.90, right here. Very nice trade; buying at $2.20, selling at $5.90. If the profit target had not yet been hit, you would sell to close the entire position if trailing stop two is hit. www.optionsincomeengine.com Page 38
Downtrend Profit Target: Okay, we want to sell to close half position at the option entry price minus ATR 20 as of setup day times 1.005 times 0.80, limited order. This strategy is aimed at selling a portion of the position into weakness capturing a very nice quick profit, which is really what we want to do in these down-trending markets, reducing position size to reduce risk at the same remain in the trade letting the profits run on the remaining half position. It s a smart way to play it because you never know when the market, especially a downtrending market, is going to reverse. If the underlying stock or ETF price moves favorably by one and a half times the ATR 20, then the option will be deeper in the money at that point with a delta of 80 or higher allowing us to take great quick profits. www.optionsincomeengine.com Page 39
Applying the short profit target to the Home Depot example, here was our setup day, our entry day, buying to open the August 27.50 put at $2.20 and what we re going to do is sell to close one half position of the August 27.50 put at the option entry price ($2.20) minus the ATR (20) as of setup day times 1.5 times.80. That gives us a limit price of $3.30. So we put this order in as a limit order waiting until the market trades down allowing this put option to increase in value from $2.20 to $3.30 and then, of course, we let the remaining half position run as far as it wants to go protected by the trailing stop. www.optionsincomeengine.com Page 40
Trading Rules Summary: Well, as you can see, these trading rules are very objective, they re potentially very rewarding and they re all summarized on a trading rules blueprint for your convenience. You re going to want to print it out and keep it by your trading computer as a reminder on the specific trading rules for each and every trade. www.optionsincomeengine.com Page 41
Action Steps: Well, make sure you understand the trading method and email us with any questions that you may have and then, using historical charts, practice identifying setups and applying the trading rules. www.optionsincomeengine.com Page 42