This is Part 5 in a series of article on my daily options trading strategy. If you have not read any of the previous four articles here on Seeking Alpha, you can click on the following links:
I like to start every article with the basics on how to use this strategy with the five technical indicators. Here is a quick summary and recap:
- Bollinger Bands - I use the 12,2,2 as my parameters, i.e. (12) as the Simple Moving Average (SMA) and Standard Deviation, (2) as the standard deviation of the top band, and (2) as the standard deviation of the bottom band. As a personal preference, I will not begin to even consider making a trade until I see the current price action move below the bottom band (calls) or above the top band (puts), but this is only one of the indicators needed out of five (5) total.
- Relative Strength Index - I use a length of twelve (12). The RSI is an indicator that shows when a stock is at overbought and oversold levels. It has a range of 0-100. A reading on the RSI of 70 indicates overbought levels, while 30 is considered oversold. Some traders like to go even below the standard 30 level for a buy confirmation, but it is ultimately the trader's choice.
- Intraday Momentum Index - The IMI is invaluable as far as I'm concerned for an options trader who gets in-and-out of positions quickly. The Intraday Momentum Index is similar to reading the Relative Strength Index, in that both of them have a range of 0-100. Again, 70 indicates overbought, while 30 is considered oversold. I also use the range of twelve (12) to correlate with the RSI. Again, it is the trader's preference as to what length works and what he or she likes to use. The Intraday Momentum Index is a very powerful technical indicator to use for any type of trader.
- Money Flow Index - The MFI follows the IMI as the next indicator. The MFI is a momentum indicator that is used to determine the conviction in a current trend by analyzing the price and volume of a given security. The MFI is used as a measure of the strength of money going in and out of a security and can be used to predict a trend reversal. The MFI is range-bound between 0 and 100 (like the RSI and IMI) and is interpreted in a similar fashion as the RSI and IMI. The fundamental difference is that the MFI also accounts for volume, whereas the RSI only incorporates price. It is also different in the fact that instead of the number 30 indicating oversold levels, the Money Flow Index uses 20 as oversold and 80 as Overbought.
- Full Stochastic Oscillator (do not use only the Fast or Slow Stochastic) - Used by many Forex traders, I find the FSO tremendously helpful in my trades as another indicator that confirms what the previous four have already done. Combining all of these indicators together really validates when it is an opportune time to buy. The FSO is a combination of the Slow Stochastic and the Fast Stochastic and is more advanced and more flexible than the Fast and Slow Stochastic and can even be used to generate them. Readings above 80 act as an overbought signal while readings below 20 act an oversold signal. The parameters I prefer to use are (10,6,6) for daily trading.
For the most part, the criteria that a stock needs to qualify it as a trade possibility follows:
- The stock should at least be $100/share or more.
- The options for the underlying stock must have liquidity.
- The underlying stock has large price swings daily (i.e. volatile daily).
- There are some exceptions, which I will mention later in the article.
To keep up-to-date with the current stocks I am using with this strategy, they are the following:
- Apple Inc. (NASDAQ:AAPL)
- Google (NASDAQ:GOOG)
- CF Industries (NYSE:CF)
- Wynn Resorts (NASDAQ:WYNN)
- F5 Networks (NASDAQ:FFIV)
- Intuitive Surgical (NASDAQ:ISRG)
- Chipotle Mexican Grill 9CMG)
- VMware (NYSE:VMW)
- Baidu (NASDAQ:BIDU)
- Salesforce (NYSE:CRM)
Frequently, I have been asked if the strategy can be used on less expensive securities? The answer is yes, but this is going to take a lot of explaining. I did not want to include other "lower-tier" stocks I occasionally use because it would have only confused the readers.
Among the other stocks I use are the following:
- Las Vegas Sands (NYSE:LVS)
- Direxion Financial Bull 3X (NYSEARCA:FAS)
- Direxion Financial Bear 3X (NYSEARCA:FAZ)
- EMC Corp. (EMC)
- Marvell Technology (NASDAQ:MRVL)
- MGM Resorts (NYSE:MGM)
- Alcoa (NYSE:AA)
- Citigroup (NYSE:C)
- Nvidia (NASDAQ:NVDA)
- SanDisk (SNDK)
- Research In Motion (RIMM)
- AK Steel (NYSE:AKS)
You should immediately notice that the above mentioned stocks that I added all have liquidity with their options. This is extremely important because the difference of even pennies in the bid/ask price can have a major effect in determining if the trade will be a profitable or not.
Since the lower-priced stocks I listed cost much less to trade, the selling price will also be much lower. In order to make this work, you will need to purchase more contracts on each trade. Often, I will purchase 100 contracts at a time on a company such as Marvel or MGM Resorts. Commission costs will be expensive, but it is offset by the lower price amount needed to exit the trade.
For example, I will use MGM Resorts as a trade here and there. If the stock is trading at $9.33/share, I must purchase deep-in-the-money options. The minimum strike price I would use for call strikes is $7.50 and for the put options it would currently be the $11.00 strikes.
Instead of using the standard $0.60 - $1.00 I use for Apple, Google, CF Industries, or any of the other higher-priced stocks, I would use $0.10 or lower with a stock such as MGM. The same would go with Marvel. If you buy 100 contracts each trade and use $0.10 above what you paid for the option as your target to exit the trade with, then this will equal $1,000.00, minus the commission costs on both sides of the trade (buy and sell). Even the most expensive online broker for commission costs should be no more than $250.00, which would still equate to a $750.00 overall profit.
If you thought that I am careful when buying options on the higher-priced stocks, I am even more selective on the "cheaper" stocks. The reason is that these stocks do not move like Apple, Google, etc.. However, one benefit is that you can use trailing stops more and not fear getting stopped out of your position. Again, this goes back to these stocks not moving by the tick as much and so quickly.
Now I want to show you an example of a Direxion Financial Bull 3X chart from Friday, December 16, 2011:
(Click charts to expand)
At 12:00 EST, this ETF clearly had an oversold (call) look to the chart (where the green "B" marker and line is pointed towards). The bottom Bollinger Band was reached and even broke it, the RSI was at 10.68, the IMI was 13.15, the MFI was a bit high at 30.77, and the FSO were at 6.70 and 9.90. This was clearly a good time to buy call options. The FAS was trading at $59.20 at this point. By using a $0.10 sell limit order above what you paid for the call options, this trade would have been easily exited by 12:04 EST, or four minutes.
Here is a chart of the Direxion Financial Bear 3X with an overbought opportunity:
This trade could have been made at 12:00 EST, as well. The ETF was trading at about $41.96. By purchasing deep-in-the-money options, you should have been able to exit the trade at 12:04 EST. The top Bollinger Band was crossed, the RSI was at 90.31, the IMI was 84.85, the MFI was 69.23 (made up for by the extremely high other indicators), and the FSO had readings of 95.03 and 91.38. This was clearly a good trade to make.
I want to show you a chart from AK Steel (AKS) from Friday. This is a great example of a trade that has to be made, even though one indicator (the MFI) was too high. At this time, AK Steel had reached a low for the day since 10:30 EST, and a small move was clearly going to come. Here is the chart:
Once again, we have another call buying opportunity at 12:00 EST. At this time, AK Steel's price dipped below the bottom Bollinger Band, the RSI was at 26.87, the IMI was at 19.89, the MFI was high at 38.46, and the FSO readings were at 15.49 and 16.19. Very clearly oversold. Yet, there is a problem. Because AK Steel is only trading at $7.50/share, the $0.10 sell order above what you paid for it is too much, and this is what I am pointing out. On a lower priced stock such as AK Steel, you may want to keep the sell orders between $0.05 - $0.08 to be sure you can out of the trade quickly. This means that you will have to buy more contracts to attain the same profits.
I would like to get into a few topics that are worth mentioning. When you see a stock or ETF reach a high or low for the day and the technical indicators are showing a good buying opportunity, with possibly one indicator being slightly off, it is usually still a good trade to make. The main thing I try to let everyone know is to avoid trading any stock when those Bollinger Bands are close together.
There is one indicator I will not allow any divergence to, and that is the Bollinger Bands. I do not care if all of the other four indicators are showing a massive oversold or overbought level. If those Bollinger Bands are not at least touched, do NOT make the trade. They are extremely important. If you stick to this rule you will avoid making mistakes.
One question I keep receiving a lot is if a certain stock is a good time to trade during the day. Many times, when going back to look at the chart to see something like this Chipotle Mexican Grill (NYSE:CMG) on Friday:
I put a "channel" on the price action from about 12:30 EST on so you can see what you should definitely not trade. Look at how close those Bollinger Bands are together. Even if the indicators had readings of less than ten across the board, I would never make a trade under these conditions. You will see similar looking charts like this in the future. Avoid it.
Also on Friday, Google had a nice put buying opportunity. It is also important to note that it reached a high for the day at this time:
This opportunity came at 11:04 EST. The top Bollinger Band was hit and just crossed. The RSI had a reading of 82.78, the IMI was at 86.10, teh MFI was at 76.92, and both FSO numbers were at 93.92 and 92.09. When you see the FSO numbers so close together like this, it really signals a great time to buy.
One thing I do not like to see when looking at the FSO is when there is one reading at 85 and the other at 62, for example, on a put buy. This tells me to wait to make the trade. The closer those two numbers are, the better the opportunity.
When you have the tab grid view up with the nine stocks on it, the main focus for you is to keep an eye on the price action in relation to the Bollinger Bands. If the price is far off those bands, then you know you will not be trading that in the near-term. Focus your time on the others in the strategy.
When you do see the Bollinger Bands being approached, this is when you will put in the ticker symbol on the main chart that has the five indicators. Trust me, this will save you a lot of time.
Back to some more charts. This is Wynn Resorts on Friday.
This is clearly a good example of when the stock is not "riding the line" or hugging the band". Often, when all stocks are sliding at the same time, you will see a few all hit their indicators at the same time. This Wynn Resorts chart was also at 12:00 EST. So what separated a good buying opportunity from a bad one? Check out this VMware chart from Friday at the same time, 12:00 EST:
Yes, VMware's price did touch the bottom Bollinger Band, but this has several factors to it that will always make me avoid making a trade when a chart looks like this. First, right before this happened at noon, the bands were close together. Second, VMware's stock was much lower than this point earlier in the day. This is the type of trade that you start to wonder if it was a good choice to buy right after you did. Look at Wynn Resorts chart and VMWare's chart. It is not hard to tell which was the right trade to make. Sure, VMware moved up soon after, but when you have a situation where multiple stocks are reaching a buy point near the same time, always go with the stock that has more expanded Bollinger Bands and just a low or high for the day.
The same situation occurred with F5 Networks at 12:00 EST, as this chart shows. Clearly, Wynn Resorts was the better choice to trade:
Stocks such as Apple or Google cost much more per trade than CF Industries or the others I use with this strategy. Since they are more expensive and higher priced, they also move more. This is where the 0.60 sell price above what you paid for it can be increased. For the most part, I like to go to a maximum of $1.00- $1.20 above my purchase price. However, if you see the trade dragging along, I would re-adjust the order to sell at the standard price. I do not recommend doing this with any of the other stocks. You will be better served buying more contracts than increasing the sell price if you would like to profit more.
On Friday, Intuitive Surgical had a chart that is a great example of what to avoid. Here is where many mistakes are made:
This chart is a classic example of "hugging the Bollinger Band" line. Notice right before it nosedived how tight the Bollinger Bands were. This is why I always stress staying away from trades when you see that. If a trader was simply looking at the numbers on the RSI, IMI, MFI, and FSO, they would make this trade thinking it was easy money. The problem is that it continued moving lower. While the stock eventually recovered somewhat, most traders would lose thousands (assuming ten contracts were purchased) and could not take those losses without exiting the trade too early. By simply looking at how the stock was moving along the Bollinger Band, this can easily be avoided. Remember, when a stock is riding the Bollinger Bands like this example, it is letting you know that there is either more downside pressure (if buying call options) or upward momentum (if buying put options). Always wait for the specific trend to finish that move.
I received an e-mail on Friday afternoon asking about a Baidu trade possibility. While the trade would have worked out great, I avoided it and I will show you why. Here is the chart:
This was a trade that could have been made at 12:30 EST. The stock eventually skyrocketed up soon after, but there are a few reasons I did not make the trade and never would. First, the price action never cleared the bottom Bollinger Band. Second, the stock was stuck in a range for a while ahead of this opportunity. It just was not a chart that had a screaming buy to it. I would rather wait for a much better chart to present itself. This is the type of trade you start to second guess the minute you make it. This trade would have taken over 40 minutes to even start to become profitable. I like my trades to sell much sooner than that.
On Friday, Apple had an odd-looking chart that is best avoided. As usual, the Bollinger Bands were tight right before a dip, and then the stock slumped, but not enough to warrant making a call trade. Here is the chart:
At 12:00 EST, the stock just touched the bottom Bollinger Band. The other four indicators had very low numbers that can falsely signal a buy. The RSI was at 20.75, the IMI was 26.06, the MFI was 7.69, and the two FSO numbers were 9.99 and 9.07. However, right before this Apple was riding the bottom Bollinger band in a minor downtrend. From 10:40 EST to 11:28 EST, the bands were extremely constricted. When you see this happen, keep a close eye on the Bollinger Band and wait until it is crossed with a conviction of oversold. This is what I like to call a "forced trade" , which is when a trader sees such a low FSO and MFI that they lose sight of what the stock was doing before this. More importantly, they are not concentrating on the Bollinger Bands and what they were indicating. Trust your instincts when trading. There is no need to jump into a trade such as this. Keep this chart as a reference.
Here is another great call buying opportunity with Marvell Technology on Friday, December 16, 2011:
As with all of the lower-priced stocks, such as Marvel, the sell order should be placed at $0.06 - $0.08 above what you paid for it.
Tips: Have your trade ticket ready
- One time-saving aspect to using this strategy is having your trade ticket ready to go once an opportunity comes along. When I have the ticker symbol up on my main screen and I see that all of the parameters are very near, I will already have the strike price and what I am willing to pay for the option already entered. This will save you the time and hassle of figuring out which strike prices to use, how many contracts, and what month. It may seem like a minor detail, but even a minute of time can be crucial with this strategy.
- I have multiple accounts with my broker, OptionsXpress.com, so I can use the Tab Grid View to see the streaming charts with the lower-priced stocks too. It should be noted that I do not use these other stocks as a replacement for the higher-priced stocks, just as an addition. I may make one or two trades a week on these lower-priced stocks.
- Get into the habit of looking at these stocks from the tab grid view (if applicable) to be able to instantly look at a chart and see if something is about to happen.
- Look at how much the strike price are trading at before making the trade, so you will have a general idea what limit order to use.
I would like to thank all of the readers of my articles on this strategy and the many appreciative comments. My main goal in writing these articles was to show a strategy that I knew worked. I hope you find success with it for years to come.
If you have any more questions or comments, you can send me an e-mail or use the comment section. I do my best to respond as soon as possible.
Additional disclosure: I am long calls on AAPL and CF, in addition to trading positions daily with the stocks mentioned in this article.