Welcome to the Rookie Blog! This week I want to talk about strategy selection. I was having a conversation with one of my trader buddies the other day and we were looking at the same chart. We both came to the logical conclusion that this chart was bullish. This is not uncommon that two traders can look at the same chart and see a similar trend, however, that is where sometimes where the agreement can end. One trader may see one pattern and another trader may see something completely different from a pattern perspective. Then there is the debate about whether or not the chart is giving a signal to trade or whether it is just starting to set up. As you can see there is a lot that traders have to review from a technical perspective before getting involved in a trade and I am going to run down a shortlist in this week’s blog and hopefully, this can help you determine what approach or strategy could work best for you and the chart you are looking at. My other hope is at the end of this we will know which way he went, and by “he” I mean “we.”
Check out the chart below, this is the chart that my friend and I had a discussion about.
The discussion went a little like this, we agreed the trend was up and we both agreed that there is a potential breakout at the 150 resistance level. This I believe is easy to recognize. What may not have been as easy to recognize was the ascending triangle pattern. One could also have noticed a pennant pattern as well but this depends on what the trader has trained their eyes to see. After looking at the chart then the discussion went to whether or not there was a trade to be had now or whether we needed more set up to give us the best opportunity. I felt that there was an opportunity right away when the double top at 147 was breached, however, my pal said that he had no interest in the trade until it broke the $150 level, so who was right? The beauty of trading is we could both be right depending on how we decided to structure the trade. The following list is things to consider before choosing the right type of trade.
- Is this a DELTA, THETA, or VEGA trade? We have to decide if we are going for a directional move or we are looking to make cashflow or maybe we are looking for an increase or decrease in volatility. This decision can help us decide whether we are going to use stock or options for this trade.
- A look at Implied Volatility can also help us decide the right path. If we have higher implied volatility then we can expect bigger premiums from options and this can make selling options more attractive than buying options. If the IV is lower then the reverse is true and we may want to stay on the buy side of a transactio.
- Time Horizon is also an important consideration, do we have earnings coming up or some other known event that can affect our trade? Also, what is our expectations about how long it can take to achieve our target price or zone
- Entry expectations, we must ask ourselves what our entry critieria is and is it ready to fire off now or will it need time to cook?
These are just a few things to think about to determine how we want to play this specific trade. Let me run down how I approached this trade and perhaps you can see which way I went. I liked the chart and I expected to enter the trade as soon as AAPL broke $147. This was both a DELTA and THETA trade for me because I was unsure if AAPL would continue on through if it hit the $150 resistance. If this stock decided to go sideways then I wanted to remain in the trade and give it every opportunity to break that $150 level and I wanted to profit from that DELTA move if it occurred. This meant that I needed to find a trade that would give me a little directional exposure and some cashflow opportunity as well. I needed to look at the implied volatility to know whether I wanted to buy or sell options and in this case the IV was low and so buying options was a better choice. I also sold options to get the cash flow component. Finally, I had to ask myself what I expected from a target perspective and how long I think it might take to reach that point. Because I was buying options I needed to give myself plenty of time to be right.
After going through all the points from above the choice became very clear that a diagonal spread was the way to go. I went out over 3 months on my long call and then I chose a shorter-term weekly option to create that much-desired cash flow. This trade gave me the ability to profit from an upswing in price but also a profit from the passage of time.
Hopefully, you can see from this a way to think through the process of choosing the right strategy or as our puppy friend said up above “which way to he go?”
Trade Well,
Coach “Old Money” Holmes
