Using Options To Forecast Share Price

Includes: AAPL, SPY
by: Mark W. Bertolin

Options Used To Forecast Share Price

The market action today with the Dow Jones Average down 257.19, the Nasdaq down 64.3 and the S&P 500 down 27.69 it is difficult to find any good news to focus on. On days like today I use the downturn to research which companies decline at a faster pace than the index they are represented by, and also those that were impacted less than the market. I also research option pricing and behavior.

When the market swings as it did today, it is important for portfolio management to understand what was impacted and why. With the various tools available down markets and bad news can be profitable. One of the tools I use is a screen of Out of the Money Call volume. Calls that are designated as Out of the Money are those that have a strike price above the stock's trading price for the day. When a strike price is higher than the stock's price it is designated as Out of the Money. I have found this tactic useful as it points to what companies the market feels have upside.

The list below represents companies highest in Out of the Money Call volume. This screen demonstrates that the Option Market is taking a stand that pricing is expected to increase for these securities. Call options can be sold to open a position in which case the seller is positioning for capturing premium now and is ready to sell shares at the strike price. If a Call position is opened by buying the Call the purchaser is positioning for a share price increase that exceeds the strike price. To profit from a purchased Call Option the Call must be sold at a higher price than the entry price.

The example below represents an Option order for Apple that utilizes both a Sell to Open Call and a Purchased Call. Selling the January 19 Call with a strike price of $580 would result in shares being sold if the price is greater than $580 in the next 73 days. The premium collected is $31.15. Purchasing a Call with a strike price of $350 for January 2014 is profitable as long as Apple trades higher than $350 and can be sold at a profit.

Prior to trading in a down market it is advisable to check what the market is saying about companies in the options market. No metric is infallible and nothing can accurately predict the direction or magnitude of price swings but reviewing the option market adds insight I find valuable when making both buy and sell decisions.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.