Basic instruments for analysis in options trading

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    1st Place! Best Binary Broker 2020!
    Best Choice for Beginners — Free Education + Free Demo Acc!
    Sign-up and Get Big Bonus:

  • Binomo
    Binomo

    2nd place! Good choice!

Options Trading Strategies: A Guide for Beginners

Options are conditional derivative contracts that allow buyers of the contracts (option holders) to buy or sell a security at a chosen price. Option buyers are charged an amount called a “premium” by the sellers for such a right. Should market prices be unfavorable for option holders, they will let the option expire worthless, thus ensuring the losses are not higher than the premium. In contrast, option sellers (option writers) assume greater risk than the option buyers, which is why they demand this premium.

Options are divided into “call” and “put” options. With a call option, the buyer of the contract purchases the right to buy the underlying asset in the future at a predetermined price, called exercise price or strike price. With a put option, the buyer acquires the right to sell the underlying asset in the future at the predetermined price.

Why Trade Options Rather Than a Direct Asset?

There are some advantages to trading options. The Chicago Board of Options Exchange (CBOE) is the largest such exchange in the world, offering options on a wide variety of single stocks, ETFs and indexes. Traders can construct option strategies ranging from buying or selling a single option to very complex ones that involve multiple simultaneous option positions.

The following are basic option strategies for beginners.

Buying Calls (Long Call)

This is the preferred strategy for traders who:

  • Are “bullish” or confident on a particular stock, ETF or index and want to limit risk
  • Want to utilize leverage to take advantage of rising prices

Options are leveraged instruments, i.e., they allow traders to amplify the benefit by risking smaller amounts than would otherwise be required if trading the underlying asset itself. A standard option contract on a stock controls 100 shares of the underlying security.

Suppose a trader wants to invest $5,000 in Apple (AAPL), trading around $165 per share. With this amount, he or she can purchase 30 shares for $4,950. Suppose then that the price of the stock increases by 10% to $181.50 over the next month. Ignoring any brokerage, commission or transaction fees, the trader’s portfolio will rise to $5,445, leaving the trader with a net dollar return of $495, or 10% on the capital invested.

Now, let’s say a call option on the stock with a strike price of $165 that expires about a month from now costs $5.50 per share or $550 per contract. Given the trader’s available investment budget, he or she can buy nine options for a cost of $4,950. Because the option contract controls 100 shares, the trader is effectively making a deal on 900 shares. If the stock price increases 10% to $181.50 at expiration, the option will expire in the money and be worth $16.50 per share ($181.50-$165 strike), or $14,850 on 900 shares. That’s a net dollar return of $9,990, or 200% on the capital invested, a much larger return compared to trading the underlying asset directly. (For related reading, see “Should an Investor Hold or Exercise an Option?”)

Risk/Reward: The trader’s potential loss from a long call is limited to the premium paid. Potential profit is unlimited, as the option payoff will increase along with the underlying asset price until expiration, and there is theoretically no limit to how high it can go.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    1st Place! Best Binary Broker 2020!
    Best Choice for Beginners — Free Education + Free Demo Acc!
    Sign-up and Get Big Bonus:

  • Binomo
    Binomo

    2nd place! Good choice!

Basics of Chart Analysis for Trading Options

Trading Options For Dummies, 2nd Edition

Chart analysis is the aspect of technical analysis that focuses on visual analysis to ferret out price and volume data that will let you discover the dominant trends in the market. There are a variety of chart types and data displays, providing you with an extremely large list of tools for analysis.

By focusing here on a handful of technical tools and techniques geared toward sector and option trading, traders new to chart analysis should get up to speed quickly while those more familiar with it will get a bit of review.

Charts are pictures that are built by plotting price data to provide you with a view of trading activity during a given period. A short list of common chart types include the following:

Line chart: Documents price movement versus time. A single price data point for each period is connected using a line. Line charts typically plot closing values, which are generally considered the most important value for the period (day, week, and so on). Line charts provide great “big picture” information for price movement and trends by filtering out noise from more minor moves during the period.

Disadvantages to line charts include the fact that they provide no information about the strength of trading during the day or whether price gaps occurred from one period to the next. A price gap is created when trading for one period is completely above or below trading for the previous period. This happens when significant news impacting the company comes out when the markets are closed. Doesn’t that seem like good information for you to have when you’re trading?

Open-high-low-close (OHLC) bar chart: Pictures price versus time. The period’s trading range (low to high) is displayed as a vertical line with opening prices displayed as a horizontal tab on the left side of the range bar and closing prices as a horizontal tab on the right side of the range bar. A total of four price points are used to construct each bar.

OHLC charts are more complete and useful over different periods of time because they provide information about both trading period strength and price gaps. Using a daily chart as a point of reference, a relatively long vertical bar tells you the price range was pretty big for the day. Another way to look at it is to say the stock was volatile that day — good information for option traders. It also hints at strength in the stock when the stock closes near the high of the day and weakness when it closes near the low for the day.

Candlestick chart: These are the most commonly used charts by professional traders. They also plot price versus time and are similar to an OHLC chart with the price range between the open and the close for the period highlighted by a thickened bar. Patterns unique to this chart can enhance daily analysis.

Candlestick charts have distinct pattern interpretations describing the battle between bulls and bears. These are best applied to a daily chart. Candlesticks also display price ranges and gaps.

View charts using both:

Longer-term line charts noting price trends

OHLC or candlestick charts for better understanding of price action during the period, including security strength and volatility

Many technical charting packages are available as independent software programs or web-based applications. The cost ranges from free to thousands of dollars, depending on the package features. When first using technical analysis, consider starting with a free web-based package and then identify your specific needs and expand from there.

Your online broker will often have a “home” charting program available. Sometimes these packages are available at some cost, whereas at other times, they may be free of charge, especially if you are an active trader. It’s a good idea to research this aspect of your broker’s services.

Best Technical Analysis Methods for Options Trading

Unlike traditional assets, options offer traders the flexibility that comes with different calls, puts, strike prices and expiration dates; not to mention the ability to create hundreds of different types of spreads and combinations to take advantage of different types of market conditions, volatility disparity as well as seasonal tendencies.

Most options traders anticipate three different types of price movements, I decided to separate and categorize the most common types of movements and then select the best technical analysis method to take advantage of that type of price movement, taking into consideration that you are trading options instead of the underlying asset.

Here are the three different possibilities:

1. Strong directional movement

One of the best technical analysis methods for finding candidates that are moving rapidly is the 20 day exponential moving average. The exponential moving average is more responsive than the traditional moving average and places more weight on more recent price data, therefore it makes a great choice to help you gauge the strength of the trend.

Another great technical filter that I like to use is 90 day price highs. According to numerous back tests, assets that make 90 day price highs, tend to continue moving in the same direction and increase momentum levels. Many traders believe that stocks as well as other assets are priced too high when trading above 90 day price highs, but if you take a look at major price breakouts that continue for months on end, they all start out with breaking the 90 day price high.

NOTE: The percentage of false breakouts is also lowest near the 90 day level and increases if you move to a substantially lower or higher time period as well.

2. Mild Directional Movement

The second type of price movement is a mild directional movement, which usually results from a bounce, pullback or a continuation in momentum after a pause. You will find that these types of movements usually occur while a trend is already on the way and the market is pausing and re-balancing before once again continuing to move in the direction of the main trend.

One very simple and effective method of identifying mild directional movements that work well with options, is to identify assets that are pulling back while in a strong uptrend. One indicator that works well for this type of analysis is the RSI indicator. I typically adjust the time period from 14 days to 10 days because my time frame is shorter; but otherwise there are no other changes that need to be made to the indicator.

While there are other oscillators that are similar to the RSI indicator, I find that the majority of these oscillators are too sensitive to price data and generate too many false signals. Therefore, I avoid the stochastic, MACD and other momentum oscillators and almost exclusively rely on the RSI for overbought and oversold analysis.

NOTE: Mild directional movement is ideal for options spreads and other combination strategies. On the other hand, if you are trading net long or short positions and want maximum directional movement, you may want to use momentum strategies that are identified in section 1.

3. No directional movement

Often times options traders, especially premium sellers want nothing more than very little to no directional movement and want to take advantage of premium decay. Similarly, when option writers sell premium, they also want a higher level of volatility, which increases the amount of premium that the options writer brings in, due to a sharp increase of implied volatility that expands when volatility increases.

One of the best methods of identifying a range bound market that has substantial range expansion is to utilize the Bollinger Band indicator.

You can see in this example, how the Bollinger Bands maintain several months of price action on the SP 500 within the upper and lower band. Notice the envelope expands and contracts as volatility or trading range moves higher and then lower, this is a good way to determine if volatility is increasing or decreasing.

If the Bollinger Band envelope is expanding, then volatility is increasing and if the Bollinger Bands are becoming narrower, then market is becoming more range bound and volatility is decreasing. Many professional traders sell options when the bands are widening and buy the options back when the bands are becoming narrower.

Another way many traders utilize Bollinger Bands, is to use the bands as support and resistance levels; to sell premiums outside of the upper and lower bands of the envelope, since these levels offer fairly conservative trading levels for both the upside and the downside.

In summary, there are different technical analysis indicators and trading patterns and each one works best in different market conditions. The type of indicator and/or analysis method you choose should take into account the type of price move you are anticipating, the options strategy you plan on utilizing and the level of volatility in the underlying asset at the current time.

Wishing you the best in your trading.

Roger Scott
Head Trader
Options Geeks

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    1st Place! Best Binary Broker 2020!
    Best Choice for Beginners — Free Education + Free Demo Acc!
    Sign-up and Get Big Bonus:

  • Binomo
    Binomo

    2nd place! Good choice!

Like this post? Please share to your friends:
Binary Options Trading Wiki
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: