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ARMH, Pocket Pivot Signals, Income Strategies

09/11/13 04:36:09 PM
by Billy Williams

If trading stocks can be compared to playing checkers then trading options is like playing chess and can give you a big edge.

Security:   ARMH
Position:   Buy

With the "summer doldrums" coming to a close as the fall season approaches, traders are beginning to take notice of the market's attempts to rally and are looking for fresh opportunities. While buying stocks is still a bit risky with the indexes still feeling some firm downward pressure there are still strategies that can help you make a steady return and control your risk. Using stock options, you can start to dip your toe in the water by looking for stocks that are firing off buy signals, but tailor your approach to minimize risk and set yourself up to make a decent return.

ARM Holdings (ARMH) is a company that engages in the design of microprocessors, physical intellectual property, and related technology and software along with its subsidiaries.

ARMH's price charts (Figure 1 and Figure 2) show a stock that is trading at the upper end of its all-time price high in a shallow Fibonacci retracement indicating that it pulled back without trading below its .382 Fib level. That means that the probability of it trading back to its previous price high of $50.56, or exceeding this price high, is very likely.

Figure 1. ARMH is trading near its all-time high and has recently pulled back to its long-term .382 Fib Retracement level.
Graphic provided by:
Price has found some support along its 50-day and 200-day simple moving average (SMA) and went through a period of price contraction from the end of July, 2013 to early September, 2013. Price traded higher on September 10, 2013 on higher volume.

This trading day would be classified as a "pocket pivot" where price moved higher on trade volume that was greater than the previous 10 trading days.

This entry signal was discovered by momentum traders, Gil Morales and Dr. Chris Kacher, as a means to get in early on a potential runaway stock that is about to break free of its base pattern.

Using a little bit of finesse with options, you can actually take it a step further and lock in some solid gains while lowering your risk, but you have to survey the current state of the market.

Figure 2. Two pocket pivot signals have fired off - one on September 9, 2013 and another on September 10, 2013. You can build an option strategy using any combination of option income strategies to lock in a decent gain while minimizing your risk using this bullish signal.
Graphic provided by:
The SPX and other indices have been trading back and forth and there is a lot of downward pressure on the market that could keep stocks from trending higher or at least slow their upward move.

The lack of movement makes it hard for stock traders to make any money but by using options you can generate some income without having to expose yourself to the risk of having a full blown stock position.

You can enter ARMH on the pocket pivot in even lots of 100 shares a piece and then sell call options on your position to generate income using the October $48 calls at a $1.80 a piece. If you bought the stock today at $47.20 and then sold the October 48 calls, then your return would be $180, a 3.8% return, plus an $0.80 capital gain if your position is called away for an additional 1.70% gain, or 5.50% in total.

Or, you could sell the October $47 puts at $2.20 each for a 4.70% return without ever having to purchase the stock. You'd have the premium collected giving you a cushion on your stop loss to around $45 a share before having to sell and you wouldn't have to pay commissions on buying and selling the stock to write the covered call position on it making the difference in returns between the two strategies negligible.

Whichever strategy you decide to use just be sure to have a contingency plan in case the stock reverses course. As in any trade, know your exit before your entry and you're more likely to end up profitable and less likely to get into trouble.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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