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A Simple Option Strategy

04/10/15 03:48:21 PM
by Koos van der Merwe

Trading options has always been a mystery to many, but with all the new weeklys and binary options that are hitting the market, they are now a strategy that should be looked at.

Security:   AAPL
Position:   Sell

In all my years of trading, even though I wrote and passed various option exams, understood them and even ran programs suggesting option trades, they never caught my fancy, and I only traded them occasionally. Trading with option greeks is what possibly put me off, that is, delta, gamma, beta etc. I always told those that traded options that my brain was not big enough to handle them.

However recently, a friend introduced me to two simple option strategies that have been exceptionally successful in my trading, so much so that I now only invest in stocks, and only trade with these two option strategies. The first strategy is selling puts and the second is selling calls.

But when do I sell a put? I will only sell a put when I know that a stock is rising, and I will sell it two strikes below its current price or, should my charts convince me that the share price will fill a gap or successfully complete any other trade pattern, I will sell an in-the-money put option.

Figure 1. Daily Chart of Apple, Inc. (AAPL). Here you see an Elliott wave count overlaid on the price chart. The Elliott wave count suggests that AAPL will soon be moving into a WAVE 5 up.
Graphic provided by: AdvancedGET.
As an example, let us look at shares of Apple, Inc. (AAPL) in the chart in Figure 1. The Elliott wave count on the chart suggests that AAPL will soon be moving into a WAVE 5 up. The probability index (PTI) suggests that there is a 77% chance that this will indeed occur. The relative strength index (RSI) is however suggesting further downside before the rise. Finally note the triangle that has formed suggesting that a break above the 125 level will see the price rise to the Elliott WAVE 5 target of $159.52. With the Apple iWatch soon to hit the market, AAPL could indeed rise strongly. So, it stands to reason that you could write (sell) a put option either at a strike below the current price or an in-the-money put at around the $133.97 level, the high of WAVE 3. The time period chosen will be at least two months, which means either an expiry date of May 15, 2015 or June 19, 2015. I make a point of never holding a put option to expiry, usually buying back the put I sold when the profit shown is above the 50% mark, one of the reasons I choose an expiry date of one or two months.

Figure 2. Options Data. Here you see the option prices offered that have an expiration date of May 15, 2015.
Graphic provided by: Scotia iTrade.
The chart in Figure 2 shows the option prices for expiry on May 15, 2015, I would probably write (sell) put options with a strike of 115 and receive $172 for every option sold. However, knowing that there is a chance that AAPL could rise if the iWatch is a success, and expecting AAPL to rise, I may therefore write (sell) an in-the-money put options at a strike of 130 and receive $810 per option sold. I look at an hourly chart to confirm taking a trade.

If I am wrong in my trade, I have two strategies that can be used. Either I accept the stock when assigned and start writing (selling) calls against it to make up my loss, or I can rollover the put option trade. By that I mean buying back the put option I sold, and writing (selling) another put at a later expiry to make up the loss.

Figure 3. Keeping Track. Here you see an Excel spreadsheet that records the sale of an AAPL put option.
Graphic provided by: Excel.
Figure 3 shows that Excel spreadsheet I use to keep track of my option trades.

Has the strategy been profitable? Very. There are occasions when I have been wrong, but a rollover soon corrects the error. Occasionally I do allow the stock to be assigned to me, especially if I want to own the stock, and then I write (sell) calls against it. However, in writing calls I am inclined to keep the expiry date as close as possible, because I want to realize a quick profit, and then write another call.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

Address: 3256 West 24th Ave
Vancouver, BC
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