“What goes up must come down spinning wheel got to go around.”

- Blood, Sweat and Tears

What really makes stock prices go up or down? Is it really as simple as what goes up must come down and vice versa? How do I select stocks with the best profit potential? Stock prices are constantly fluctuating and many times there seems to be no ‘rhyme or reason’ to this constant price fluctuation. The air waves and the Internet are flooded with analysts and experts who try to predict the future price moves for stocks.

Often they have no real answers to our same questions and are just as baffled by why a stock is going up or going down. Where does that leave us? Let’s face it; to the average investor the stock market can seem complicated and confusing.

Stocks can go up or down for no apparent reason. Apple reports great earnings but the stock plummets. The price of oil drops and the inflation report is tame but the major stock market indexes dive. Pfizer reports terrible earnings but the stock rallies. With the spinning wheel, going round and round, the ups and downs of the markets can leave anyone’s head going round and round. When it comes right down to it, the reason why stock prices are going up or down seems to be anybody’s guess. You might as well try to read tea leafs.

Highly paid analysts would have us believe that a company’s earnings outlook drive stock prices. Yet how many times have you seen the stock of companies with good earnings plummet while those with terrible earnings soar? Just like bad things happen to good people, big stock declines can happen to good companies. It is a fact of life with no true explanation.

But none of that matters for one simple reason. At the end of the day, if there are more buy orders for a stock than sell orders then the price of the stock will go up. And if there are more sell orders for a stock than buy orders, then the price of the stock will go down. It’s just that simple. Everything else is just noise. Everything else does not matter.

To make real money in the stock or options markets you don’t need to know why a stock price rises or falls, you just need to know two things: when to buy and when to sell. If you can quantitatively measure the buying and selling pressure of a stock then you will know in advance whether the price of a stock is likely to go up or down. And you will then know if you should take a bullish or bearish option position.

In other words, if you get a reading on the buying pressure and selling pressure for a stock you can successfully assess whether a stock is likely to go up or go down in price. There are numerous ways to measure the buying and selling pressure of a stock. We want to teach you several methods. That way you can use all the methods or just work with the methods you are most comfortable. Remember comfort and ease are what we are aim for!

The best way to measure buying and selling pressure is to track the daily price movement of a stock. If the daily price of a stock is increasing then the buying pressure is exceeding selling pressure and the stock is a ‘buy’. If the daily price of a stock is decreasing then the selling pressure is exceeding buying pressure and the stock is on a ‘sell’ signal.

One of the most important rules we learned as a novice investors was that you want to purchase a stock or call option only if the buying pressure exceeds selling pressure as indicated by the price of the stock trending up.

Trying to profit by investing in a stock with a price that is trending down is very difficult as it requires that you correctly predict when the price of the stock will ‘bottom out’ and resume a price up trend so that your stock or call option purchase can be profitable.

Buying a stock because it is cheap and then trying to predict when a stock’s price will bottom out can be nearly impossible to forecast correctly on a regular basis. This ‘crystal ball’ type of approach can leave the investor in a vulnerable position. A safer approach would be to wait until a stock’s price is in an uptrend before investing

A stock’s price movement reflects all of the known information about a company so let the price movement of the stock tell you when you should buy and sell!

One of the most effective ways to measure buying and selling pressure is to look at the daily price movement of a stock. There are numerous methods for tracking the daily price movement. We want to teach you one of our favorite and most effective ways. It is using a price chart.

Price charts are a great way to get a visual look at the daily price changes and the price trend of a stock. It is the price trend that will determine if the stock is on a ‘buy’ or ‘sell’ signal and whether a bullish or bearish option trade should be taken.

For example, if the daily price trend of a stock is increasing then the buying pressure is exceeding selling pressure and a call option position should be initiated. If the daily price trend of a stock is decreasing then the selling pressure is exceeding buying pressure and a put option position should be initiated. Let’s take a closer look at price charts and how this tool will lead us to the path of success.

Daily Price Trend of a Stock Is Increasing = Call Option Position

Daily Price Trend of a Stock Is Deceasing = Put Option Position

Using Price Charts

Price charts are a great tool that helps us determine a stock’s price trend. The daily price chart below displays the daily price movement for Apple stock over a one month period. The horizontal axis at the bottom of the chart references the time period of the chart which is one month in this example from March 8th through April 8th. The vertical axis on the right side of the chart represents the price of Apple stock and in this example ranges from 218 to 242.

The vertical bars display the daily price movement of the stock. Each vertical bar has a horizontal line which represents the stock’s closing price for the day. On March 22nd the daily bar shows that Apple stock traded in a range from about 220 to 226 (circled). The closing price on March 22nd which is represented by the horizontal bar was about 225.

Determining the Price Trend

As noted previously we only want to buy a stock or call option if the buying pressure is exceeding the selling pressure as indicated by the price of the stock trending up. The best time to buy a call option is after the stock is already in a price up trend. We want to avoid stocks that are in a price down trend.

Daily price charts like the one just presented for Apple allow us to instantly see the price trend of a stock. We like to take this visual look at a stock’s price movement one step further and actually measure the price movement. The easiest and simplest way to measure price movement is to use what are called ‘moving average lines’.

Next, we are going to take a look at when to buy and when to sell. This concept always reminds me of an old Kenny Rogers song:

You got to know when to hold ‘em, know when to fold ‘em - Know when to walk away, know when to run.

Yes, with stocks you need to know when a stock is on a ‘buy’ signal or ‘sell’ signal. You are about to learn indicators that can quantitatively measure if a stock is moving up in price or moving down in price.

These indicators let us know in advance the most likely future price movement of a stock. We will then know if we want to buy call options or put options.

Determining the Most Likely Future Price Movement

Moving Average lines are a great trading tool that allows us to know in advance the most likely future price movement for a stock. We know the term Moving Average line may seem complicated but a Moving Average line is simply the average closing price of a stock over a specified time period. For example, the 50-Day Moving Average line represents the average closing price of a stock over the past 50 days.

Many times the real price trend of a stock can be obscured by the daily price fluctuations. The daily price chart below for Apple stock covers the 3 month period of November, December and January. As we learned in the previous price chart example for Apple, the vertical bars display the daily price movement of the stock.

This price chart shows a rally for Apple stock until mid-November and then a price decline into mid-December. This price decline is followed by another rally into the beginning of January followed by another price decline in January. Despite the daily price fluctuations the stock price was little changed over the 3 month period.

Three Month Price Action Shows No Clear Trend

Let’s take another look at a price chart for Apple stock that covers a longer time period but includes the November, December and January period just mentioned. This price chart also includes the 100-Day Exponential Moving Average (EMA) line for Apple stock. We prefer to use Exponential Moving Averages over Simple Moving Averages as we have found Exponential Moving Averages to be more accurate in determining the price trend. Exponential Moving Averages give more weighting to recent price movements than Simple Moving Averages which give every day an equal weighting.

100-Day EMA Line is Sloping Up

Clearly Indicating a Price Up Trend

The 100-Day Exponential Moving Average (EMA) line is sloping up clearly indicating Apple stock is in a price up trend. Moving average lines give us an instant visual reference of the current price trend of a stock.

4. If the moving average line is sloping up, the stock is in a price up trend and buying pressure is exceeding selling pressure. Call options should be purchased.
5. If the moving average line is sloping down, the stock is in a price down trend and selling pressure is exceeding buying pressure. Put options should be purchased.

It is that simple! Moving averages tell us if a stock is on a ‘buy’ signal or ‘sell’ signal instead of trying to predict the future price movement of a stock. You can easily and quickly obtain moving average lines from numerous websites which will be covered shortly.

Buy and Sell Signals

One of the easiest ways to clarify whether a stock is a ‘buy’ or a ‘sell’ is to look at the shorter term 50-Day Exponential Moving Average (EMA) line in relation to the longer term 100-Day Exponential Moving Average (EMA) line.

If the shorter term 50-Day EMA line is above the longer term 100-Day EMA line it indicates the price momentum for the stock is to the upside which confirms the price up trend. We should initiate a call option trade for the stock.

If the shorter term 50-Day EMA line is below the longer term 100-Day EMA line it indicates the price momentum for the stock is to the downside which confirms the price down trend. We hould initiate a put option trade for the stock.

Buying and Selling Pressure

When the shorter term 50-Day EMA line is above the longer term 100-Day EMA line it is an indication that the buying pressure for a stock is exceeding the selling pressure. And the most likely future price movement of the stock is up. The stock is on a ‘buy’ signal.

When the shorter term 50-Day EMA line is below the longer term 100-Day EMA line it is an indication that the selling pressure for a stock is exceeding the buying pressure. And the most likely future price movement of the stock is down. The stock is on a ‘sell’ signal.

‘Buy’ Signal Example

Let’s look at an example of a ‘buy’ signal. The Apple stock daily price chart below displays the 50-Day EMA line and the 100-Day EMA line. The moving average lines indicate that Apple stock entered a price ‘up’ trend in April (circled) as the 50-Day EMA crossed above the 100-Day EMA line.

When the 50-Day EMA crossed above the 100-Day EMA it was a good indication that buying pressure was exceeding selling pressure and you want to take bullish option trades for Apple. As long as the 50-Day EMA line remains above the 100-Day EMA line Apple stock remains a ‘buy’ and bullish option trades should be maintained.

In this example the Apple 50-Day EMA line crossed above the 100-Day EMA line in April. We purchased Apple stock and call options after the April buy signal. Apple remains in a price ‘up’ trend if the 50-Day EMA line remains above the 100-Day EMA line indicating that buying pressure continues to exceed selling pressure. Monitoring the 50-Day and 100-Day EMA lines is an easy and effective way to determine the current price trend which tells us if we should be taking bullish or bearish option trades for Apple stock.

If the 50-Day EMA crosses below the 100-Day EMA it would indicate a reversal to a price ‘down’ trend as the selling pressure is now exceeding the buying pressure. You should take bearish option trades for the stock when this occurs. We will look at an example of a sell signal next.

50-Day EMA line Above 100-Day EMA line = Buy

Sell Signal Example

Let’s look at an example of a ‘sell’ signal. The daily price chart below shows the daily price movement and the 50-Day and 100-Day EMA lines for Merck stock. This chart reveals that in February the Merck 50-Day EMA line crossed below the 100-Day EMA line (circled) resulting in an EMA System ‘sell’ signal for Merck stock.

When the 50-Day EMA crossed below the 100-Day EMA it was a good indication that selling pressure was exceeding buying pressure and you want to establish bearish option positions for Merck stock. You want to hold on to the bearish option positions for Merck while the price trend is ‘down’ and at this point the length and severity of the price decline is still unknown.

As long as the 50-Day EMA line remains below the 100-Day EMA line Merck stock remains a ‘sell’. Merck does not qualify as a buy until the 50-Day EMA line crosses above the 100Day EMA line.

Monitoring the 50-Day and 100-Day EMA lines is an easy and effective way to determine the current price trend which tells us if we should be establishing bullish or bearish option positions for Merck stock.

50-Day EMA Below 100-Day EMA = Sell

The 50/100-Day EMA trend following system is your road map to investing success. Trend following is a powerful, systematic approach that allows us to profit from the powerful profit opportunities available from trading weekly options.

Historical Results Of EMA System

The 50/100-Day EMA System is a rule based system with clearly defined ‘buy’ and ‘sell’ rules. This enabled us to do historical testing with the help of the Omega Research Trade Station program using the 50/100-Day EMA Cross Over System just presented. Historical profit results are based on buying a stock when its 50-Day EMA line crosses above the 100Day EMA and selling a stock when its 50-Day EMA line crosses below the 100-Day EMA. The profit/loss for each trade is calculated and a cumulative total is maintained for each testing period.

The EMA System is universal in nature and has been profitable for short term investing across a wide range of markets including: stocks, options, indexes, closed-end funds, zero coupon bonds, mutual funds, index funds and sector funds. The fact that the system is profitable in virtually every type of market confirms its credibility as a viable, robust approach to trading the financial markets.

Included on the following page are profit results for a well-diversified sampling of both growth and value stocks that represent a broad cross section of 26 different industry groups. This sampling includes small, mid and large cap stocks. Historical profit results were generated over a recent twenty four year period.

Profitable with Low Risk

Keep in mind that four bear markets occurred during this period. Results are based on trading one hundred shares of stock for each ‘buy’ signal and do not include commissions.

Let’s review the tests conducted using the first stock tested Aetna Health Care (AET). The first time Aetna’s 50-Day EMA crossed above the 100-Day EMA during the test period one hundred shares of Aetna were purchased at 10.18.

The profit/loss for each AET trade was calculated by the Trade Station software and the profits totaled $5,376 over the test period based on trading 100 shares for each buy signal. This $5,376 profit represents a 528% return on the initial investment of $1,018.

The software divides the total profits by the total losses to calculate the Reward to Risk Ratio. Aetna had a Reward to Risk Ratio of 3.9 as there were 3.9 dollars of profit for each 1 dollar of loss. There were 10 losing trades over the 24-year period and the average losing trade incurred a -$120 loss.

Average Yearly Return of 107%

The total initial investment required to buy 100 shares of each of the 34 stocks over the test period was $8,204. This $8,204 initial investment produced a total of $210,578 in profits over the test period which equates to a 2,567% return. The average yearly return was 107% which would enable us to double our initial investment every year on average. This average 107% annual return was achieved without the use of leverage or margin. Trading options instead of stock would have resulted in a much higher rate of return over the test period as options provide leverage.

The historical results demonstrate that the EMA System has the ability to produce ample profits with very low risk. Of the trades that were losing trades, the average loss over the twenty four year period was $150 and when compared to the total profits of $210,578 demonstrates the ability of the system to keep losses to a minimum. The average Reward to Risk ratio was a very healthy 12.7 with over 12 dollars of profit for each 1 dollar of loss again demonstrating a very healthy risk-adjusted return.

The preceding investing results demonstrate the importance of ‘investing with the trend’ if you are a short term investor. The 50/100-Day EMA System allows us to know in advance the most likely future price movement of a stock and reduces the entry and exit timing risk associated with short term investing.

It is a versatile, effective method for profiting in any type of market and can quickly identify stocks on a ‘buy’ or ‘sell’ signal. This allows us to profit from trading options by purchasing call options for a stock on a 50/100-Day EMA System ‘buy’ signal and purchasing put options for a stock on a 50/100-Day EMA System ‘sell’ signal.

Equally important is the ability of the system to avoid large losses which can quickly ruin an investment plan. The system keeps losses to a minimum and almost always exits a trade before a big loss occurs. Following a discipline that keeps losses to a minimum is one of the most important characteristics of a successful short term investing program. Keep in mind that the worst bear market since 1932 occurred during this test period.

The 50-Day and 100 Day-EMA Lines Are the Key to Developing a Profitable Strategy

The stock market is in a constant state of flux. The constant up and down price movement of a stock makes it difficult at times to see the real price trend of a stock. That is why it is important for an investor to become comfortable with the 50/100-Day EMA lines.

The position of the 50-Day EMA in relation to the 100-Day EMA gives us a quick and accurate indication of a stock’s current price trend. If the stock is in a price up trend call option trades should be initiated. And if the stock is in a price down trend put option trades should be initiated. In order to be a successful option investor we do not have to know what an analyst’s rating is for a stock or the current earnings projection. All of that information is already reflected in a stock’s price movement which can be quantitatively measured by the 50/100-Day EMA lines.

This simple but effective trend following system is mechanical in nature and instantly tells you if you should be taking a bullish or bearish option position. We prefer mechanical systems as they take the emotion out of trading. There is no judgment or interpretation involved. You don’t have to rely on trying to predict future price movement.

Follow the Price Trend Instead of Trying to Predict It
“Prediction is very difficult, especially if it’s about the future.”

- Nils Bohr

The 50/100-Day EMA System allows us to ‘invest with the trend’ instead of trying to predict the price direction of a stock. The historical studies presented demonstrate that price trends tend to continue in the same direction and can continue on longer than one may initially expect.

Our investing experience confirms that the 50/100-Day EMA System allows us to know in advance the most likely future price movement of a stock and whether we should be initiating bullish or bearish option trades.

THE SPECIAL OFFER

To learn more about Chuck’s unique approach to options trading, tap the link below to get a free copy of his new eBook “Options Trading Made Easy”.

This free options trading course will teach you everything you need to know if you want to start trading options in the simplest, most profitable way possible.

ABOUT THE AUTHOR

The debit spread is a trading strategy that all options traders should not only know how to use, but also how to adjust. In this video, you will not only learn how to trade debit spreads, but I will also share with you one of my favorite trading strategies that is a powerful way to capitalize on trend and momentum, using three simple indicators.

THE SPECIAL OFFER

Learn to trade options the right way with clear and simple rules and strategies that are working in today's markets.

ABOUT THE AUTHOR

Four times each year, stock and equity options traders’ ears perk up.

Like clockwork, their gears start to turn and they type away at the keyboard, looking for the earnings season schedule of big-name companies like Google, Apple, Netflix, Tesla… The list goes on. It’s like an appointment for profits.

Each earnings season, the stock market sees a spike in volatility, in profit potential, for traders with a weather eye on the horizon. As stock traders take to the charts, equity options traders do the same, looking to take advantage of stock movements for pennies on the dollar and get a little piece of the pie.

What if you could do the same?

What if each quarter, you set aside a handful of hours to execute a few options trades where you could potentially profit 25-30% overnight?

It happens, and more frequently than you might think. I’ve been trading for more than 15 years and I’ve not only seen it happen through my students’ successes at Market Traders Institute, I’ve watched it happen in my own account too. The beauty of it is that no matter what time of year it is, you could be preparing for earnings season.

This is the precise strategy that I use each and every quarter…

What is the Earnings Season?

Earnings Season: The time around the beginning of each financial quarter when publicly-traded companies release earnings reports for the previous quarter.

The Catch

Despite what some traders will tell you, as an equity options trader, the actual earnings number is not the issue. I really don’t even care if the company makes money or loses money.  What counts is how investors react to the news.

What is the important part? The knee-jerk reaction of investors.

Because investors assign a positive or negative emotion to those numbers, the stock can jump, or dump. These moves can make for great opportunity if you know how to play the move. 

I focus on the reaction that the stock's price has to the earnings number.

That’s what will drive the intrinsic value in my options, and therefore the profitability in the trade. The intrinsic value of an option is the component of the options price that is DIRECTLY affected by the movement of the underlying stock. If the stock goes up $1.00, the intrinsic value goes up $1.00. That is why we need the stock price to move big. In order for a straddle to work, intrinsic value needs to take off.

The other day, Netflix (NFLX) had its earnings announcement. The company made $0.06 per share, but the bigger story to me was that the $100.00 stock moved approximately $17.00 the next day. That is the type of move that we are after. The total cost of the straddle in this situation was on $12.80 per share.  Since the underlying stock moved $17.00, the intrinsic value boosted the trade to a profit. Like I said, I don’t care about the $0.06. I care about the $17.00 and what that move will do for my options. 

One of the great things about a straddle trade is that I really did not even care if the stock moved up $17.00 or down $17.00. I would profit either way. That is correct – I do not have to choose a direction. It’s just one more way that this strategy takes the stress out of your trades.

The 4-Step Earnings Season Profit Plan

The Straddle Trading Strategy

An options straddle blows some traders’ minds. You don’t pick the stock’s direction. Truly, your only concern is that the stock moves. Period.

Not a bad strategy, right?

Volatility: The amount of market action. Also known as “the spread” in the market’s waves or the price fluctuations a stock experiences.

Typically, if you’re buying a call option, you’re looking for the stock price to go up.

If you buy a put option, you are looking for the stock’s price to move down.

In an options straddle, you buy a call and buy a put simultaneously.

When you place these orders, you just want the stock to react to the earnings announcement. The bigger the reaction the better. Positive or negative does not matter, we just want it to move dramatically. 

Options Straddle: When you buy a call option and buy a put option at the same time, you straddle the market price so that no matter which direction the stock moves, you could profit.

Why Trade In Both Directions?

So you might be thinking, if I’m trading in both directions, won’t the trades cancel one another out? Or worse, won’t that mean that the market will inevitably go against me?

Yes and no.

When the market moves big in one direction, one of your options, either the call or the put, will increase in value. The other decreases in value. You will be losing money in that negative trade, but the objective is to have the winning trade outweigh your losing side. This is where you start to see profit. The profit of the winning trade should be much larger than the loss in the losing position. As a matter of fact, your loser may get crushed into oblivion. The good news is that when you buy options, your risk is limited to the cost of the option, and your reward is unlimited.  So if your winner increases by more than the cost of the total loser, we have a winning straddle.   

How it Works

The key is buying equal numbers of “at the money” calls and puts prior to the announcement. This is why having the announcement release date on your calendar is so critical. When you buy an equal number of at-the-money calls to puts, you are creating a “delta neutral” strategy. At-the-money call options will have deltas of .50, and At-the-money put options will have deltas of -.50. When these deltas are added together, we end up with a delta of “0,” or delta neutral.

Delta: Stemming from the Greek word diaphora, which means “difference.” This number tells you how much you will profit based on a $1.00 move of the stockl e.g., if a trader buys an option with a 0.75 delta, and the underlying stock moves $1.00, the option will increase in value by $0.75.

Delta Neutral: Puts always have a delta from -1 to 0 and calls from 0 to 1, so when you buy a put with a delta of -0.5 put and a call 0.5 delta, your deltas will cancel each other out and you will be left with a delta neutral position.

You are dealing with two deltas in this case.

Let’s say that we get into a straddle trade where the call option has a delta of 0.50 and the put option has a delta of -0.50. The earnings are released and the stock gaps up in the pre-market. This causes the call options to increase in value, and along the way the delta is ratcheting up, 0.50, to 0.55, to 0.60, to 0.65 eventually moving up to 0.85. This means that my call option is now making me $0.85 every time the stock move up $1.00. That is great!

But what about the put positions? The put delta will start moving in the opposite direction; -0.50, to -0.45, to, -0.40, eventually falling to -0.20. The put, being on the losing side of the trade, is actually losing money slower. In this case, at this level, the put option is losing $0.20 for every $1.00 the underlying stock price moves up. Here is the great thing about the current state of our hypothetical trade.  We are making $0.80, with our Call option, for every $1.00 move of the underlying stock, while we are losing $0.20 for the same move with the put.  The net result is a $0.60 profit. That is why straddles work! 

PRO TIP: The Ultimate Stock and Options Course teaches to buy options with deltas between 0.5 and -0.50 for straddle trades during earnings season. (The trade is not a straddle if you use options with deltas other than 0.50 and -0.50.)

When to Straddle the Market

It’s simple really. The straddle strategy allows a trader to take advantage of a known event that has a high probability of causing the stock to move 10% to 15%, regardless of direction. This is why it’s a perfect strategy to master when trading earnings announcements.

The Key to the Straddle

Understand this: a straddle is not an ideal strategy for every stock at earnings. The reason is that not every stock has the potential for the required move it will take to put the trade into a profitable position. For this reason, you will need to do your homework before placing a straddle.

Now, let’s explain the top five ways to judge whether or not a particular trading opportunity is a good pick for an earnings season straddle trade.

5 Steps to Successful Options Straddles

Step 1: Stalk Your Prey
First and foremost, you’ll need potential stock shares that you’ll want to monitor. All of the following steps require that you have particular companies in mind, access to their current share prices and, preferably, have an idea of when their earnings reports will be released for the coming quarter.

Step 2: Look to the Past to Profit in the Future
Now that you have several stocks in mind, you’ll want to look back on the historical data for the stocks in question, be it Apple, Google, Netflix, Tesla,whichever stock you’re looking to profit from.

To do this, you want to look back on the stock charts and identify the four most recent earnings report releases dates. Once you have found them, check out the price fluctuations in that company’s stock price following each announcement.

You’ll want to answer three questions:

1. What was the closing price prior to the announcement’s release?
2. What was the opening price the day after the announcement’s release?
3. What was the peak or valley before turn price – after the announcement’s release?

Peak or Valley Before Turn Price: The price the stock hits, before its first reversal, after the report’s release.

The measurements from close to open, and close to peak/valley can give you an indication as to whether the stock has moved substantially in the past at earnings announcements. If the cost of the straddle is less than the historical movement at earnings releases, you may have a potential straddle candidate.

Example:

Let’s take a look at an older example of this for the sake of clarity.

Below are four consecutive earnings report numbers for Netflix (remember that you’ll always want to pull the four MOST RECENT earnings numbers for judging your potential straddle trade):

• Earnings Report from 1/20/15
  • Pre Earnings Close - $349.40
  • Post Earnings Open - $414.68 ($65.28 move or 18%)
  • Post Earnings Peak - $457.38 ($108.28 move or 30%)
• Earnings Report from 10/15/14
  • Pre Earnings Close - $448.59
  • Post Earnings Open - $332.73 ($115.86 move or 25%)
  • Post Earnings Low - $331.00 ($117.59 move or 26.2%) – immediate bounce
• Earnings Report from 7/21/14
  • Pre Earnings Close - $452.00
  • Post Earnings Open - $442.98 ($9.02 move or 1.9%)
  • Post Earnings Low - $412.51 ($39.48 move or 8.7%)
• Earnings Report from 4/21/14
  • Pre Earnings Close - $348.49
  • Post Earnings Open - $376.63 ($28.14 move or 8%)
  • Post Earnings Peak - $380.88 ($32.39 move or 9.2%) – immediate drop

In these examples, you can see that the two most recent earnings releases caused the stock’s price to move between 18% and 30%. If we were looking at a straddle that hypothetically cost 15% of the current cost of the stock’s price, the trade would have potential.

What’s the Magic Number?

Unfortunately, there is no magic number and there’s no holy grail. In the past, I have looked for stock price fluctuations between 12-15% minimum. That often creates enough movement to produce a profitable trade in a straddle situation. The only way to truly make a sound judgement is to determine the current price of the straddle and compare that price against the average price movement over the past four earnings releases. If the cost of the straddle is greater than the average move, the trade probably will not work. If the average move is greater than the cost of the straddle, the trade has a good chance of working.

Step 3: Let the Big Dogs Weigh In

Now, this is a dangerous one if you’re not careful. While we want to consider what key analysts are projecting, we don’t want to trade the news, we want to trade the moves. At the same time, once you have your stock picked out in Step 1, it’s good to check in on the analysts’ insights. 

You want to focus in on the highest analyst price target. When the cost of the straddle is added to the current value of the stock, you arrive at a number that is less than the analyst target, indicating that your straddle has the potential of working out.

PRO TIP:  Don’t pay attention to the earnings estimates. Instead, look to see where the analysts have set their highest price targets for the stock. This is what they think that the stock is worth. Traders like to drive prices up to the analyst targets and stop, so if the straddle profit target is lower than the analyst price target, the straddle should be in good shape.

Step 4: Don’t Forget the Fibs
The Fibonacci sequence is an old mathematical golden ratio you probably learned in some middle school or high school math class and quickly forgot about it, dismissing it as something you couldn’t possibly, ever in a trillion years use… That is, until you began to trade the markets.

The next step (the decision-making process) for your trade is to draw out the Fibonaccis.

In this instance, you want another point of confirmation. You’re looking to be able to say that the stock has the potential to make the range of movement you’re after within the current extension or retracement. If it is not, then your technicals do not match up with what you require to be profitable in your trade. While this may not be a 100%, sure-fire way to decide whether or not to avoid the trade, it is a critical component many traders take into consideration in passing up a trade.

See what the Fibs look like on the charts:

Step 5: Give the Volatility Charts a Vote

Have you ever seen a volatility chart? These charts help options traders determine whether an option is overpriced or underpriced. This is a wonderful gauge for seeing if the options are priced at a level that is just too expensive to place the straddle.

The chart is very visual, and simple to read. The chart will have two lines. One shows the historic volatility and the other represents the implied volatility. If the implied volatility line is higher than the historic volatility line, the options are thought to be expensive. If, on the other hand, historic volatility is higher than implied volatility, the options are thought to be inexpensive.

What we really want to see is just how expensive our options are. What you’re looking for is the skew between the historic and implied volatility. The closer these two numbers are together, the smaller the skew. The smaller the skew, the less expensive the options and the better your chances will be of covering the cost of the straddle. The wider the skew, the more expensive the trade becomes and your chances of covering the straddle cost goes down.

Skew: A fancy math term for the difference or distance between two numbers.

Historic Volatility: Gauge of how much the stock’s price has flopped around and moved based upon past data.

Implied Volatility: Representation of the average analyst sentiment as to what they believed the volatility will be in the future. (This directly ties into Step 2!)

CONCLUSION

Earnings season trading is as close to appointment-style trading as you can get. With just one strategy, the options straddle strategy, you could have a payday scheduled for every quarter.

Do you want to get more hands on experience with this strategy?

THE SPECIAL OFFER

Make your money work for you!  Join 7 investment experts in a live, Q&A webinar to help you find the investment market that’s going to take you farther.

ABOUT THE AUTHOR

When I was a kid, my father used to always tell us to keep the screen door closed. We lived in a rural area and it seemed that all the flies would congregate at our house. Whenever someone opened the door, the flies would enter. If you ever enjoyed the experience, flies have a way of relentlessly buzzing around your head at 5 am. Most annoying, the only thing to do was to wake up and swat them. Of course, by that time, it was your sleep that was interrupted, and often made for a miserable day to come.

Knowing how irritated these insects can be, not to mention unsanitary, my dad would go on his nightly ‘fly patrol’. It was amusing to watch him take the vacuum cleaner and suck up these bugs. The kids would have to track them, then my dad would sneak up quietly behind them with the hose and instantly, they were history. Gone. Joined the rest of their buddies along with the dust and other garbage sucked in from the day’s house cleaning. It actually felt good, rather rewarding. Growing up, we kids would also partake in this fly patrol to ensure a good night’s rest.

As we got older, my dad would use his screen door analogy as a metaphor for greater things in life. “Watch your screen door”, he’d say if he saw some distasteful people lingering in our midst. Of course, nobody would enter our lives as an enemy; we would know that and be able to tackle them before they could do harm. Most people who turned out to be enemies would enter as acquaintances or friends, then slowly annoy us to the point they could distract or harm us. Often we would be unaware of what was going on until some damage had already been done, just like the flies.

We extended this protectionism to all facets of our lives. Physically being the obvious but also mentally and spiritually. By creating some kind of a shield around us, we are able to withstand the onslaught of the enemy, so to speak. “Always be aware of your surroundings”, we were told. We are judged by the company we keep and our behavior. Looking back, whenever I got into even the slightest trouble, I can trace it back to ’not closing my screen door’.  As with the flies, any grief in my life was likely caused by my carelessness.

Background:

My strategy calls for a simple technique that earns me 5% or more per day, trading one outstanding stock, engaged for only about an hour a day. My methodology is not that difficult to learn but does have to be mastered, especially the mental aspect of the game, if you want to succeed. This article will address that psychological quality of trading, a topic that seems so elude most every trading ‘guru’ out there, likely because they do not know how to address it. Yet once understood, your risk will instantly diminish.

My name is Hugh and I am the Head Trader/Trainer for daytradespy.com. Over the years, I made a lot of money and I lost a lot of money, but I always took away a lesson from those losses.

Eventually, I started making some serious money. Then my friends, family and acquaintances saw me bringing home all the toys… exotic vacations, cars, houses, even a new airplane. They couldn’t contain their curiosity and wanted to know what I was doing. Hence we grew to what we are today.

Understand this Business:

Before you embark on your trading career, do understand what this is about. If you treat is as business, it will pay you as such. If you treat it as a hobby, it will treat you in the same manner. Those who give it their serious effort tend to do much better than those tinkering with trades.

Most traders – 90-95% - are out of this business the first year. They simply lose all their money. So the idea is to stay the course, learn all you can and master your one great strategy that works best for you.

This is not a ‘one size fits all’ endeavor. Every trader will have his/her own style, risk tolerances and parameters with which they can work. One fallacy that keeps surfacing is that traders often look to mimic others, thinking they will emulate their mentor’s trades. I can indicate when I will enter a position and you may follow, but we may well exit at different positions. The problem with that is that the follower is not necessarily learning what is being taught, and therefore destined to lose at some point.

As not every trade will be a winner, it is only a matter of time when something goes horribly wrong and the follower gets burned, with or without their leader. It is for that reason that it is imperative that all traders need to understand their trades. Become at one with the market, embrace a viable strategy and make entries and exits second nature, irrespective of your leader. It is incumbent upon all traders to take responsibility for their own trades.

That is not to say you cannot follow someone’s lead; just be cognizant of the inherent risks involved. I have some folks, for example, enter on my morning picks looking to take 8% per trade, simply because my published results support such a risk. Other traders are more comfortable taking 6% but doing it several times a day because they know how the system works, and by taking a lesser profit, they reach their targets sooner and more often. We each have our own styles.

Trading is much like professional sports. You’re only as good as your last game. How we deal with issues, both on and off the game, will impact our trading results. If you are still wound up over an argument with your spouse, it is probably a good idea to stay away from trading. Remain emotionally cool at all times.

I like to trade no more than several times a day. Good or bad, I would be emotionally charged, and thus subconsciously expecting some result from my trades. If I come off a series of great trades, I would anticipate another one, and it is easy to expect the market to deliver. Fact is, the market owes you nothing and can do whatever it wants, setting yourself up for disappointment. Always remain aware of your emotional quotient and stay humble.

Trading is not like any other business. It has no goodwill. Unlike, say a great restaurant that has been around for many years with an outstanding reputation, should the chef have an off night, it does not mean the restaurant is in trouble. Customers would likely dismiss it as an unusual night and return later. That goodwill has value.  With trading, there is no such thing. You could be a hero one minute, a zero the next.

As traders, we often look to others for guidance. In particular, traders are attracted to live trading rooms. Here again, be judicious of how it operates. If there are a number of participants, you will likely find that the masses gravitate to the most charismatic personality, irrespective of their trading prowess. I once observed a trading group with perhaps 30 people in it, 29 of which immediately dumped their SPY holdings when one of the moderators suddenly yelled “Sell, Sell, Sell!” The market suddenly tanked. Guess where I was in that fiasco… I was one of the 29 losers. Lost thousands. Yet had I held my own mindset, I could have cleaned up in that move.

The trading business has the ability to change course in a heartbeat. Unlike our institutional counterparts, the retail trader can alter focus should the winds change direction. This is both a blessing and a curse. The unsophisticated day trader may make these changes on a whim, often getting whipsawed out of trades they would otherwise profit handsomely in. Often times, the novice enters a winning trade, riding the profit while increasing the sell point cent by cent. This undoubtedly will reverse, then the trader follows it back down, selling for a loss. It is actually amazing how traders are happy they sell for a loss… “I could have lost more”, they claim. Then the joy turns to sadness when they watch their now dumped trade turn back into a profit, as if it is still their trade. Know that once you leave a trade, it is gone. No longer yours. Never look back.

Conversely, I often hear of traders get angry because they only profited 10%, as they watch their stock climb higher. These are legitimate pangs of anger they feel. My response: never regret taking a profit. You will never go bankrupt by taking gains. Like a city bus, if you miss a trade, there’s another one around the corner. Be happy with your earnings.

Never overtrade. I used to trade 6 to 10 times a day, and did quite well at it, for the most part. Invariably that last trade of the day, where I was so sure of my profits, turned against me. “How could the market do this to me?”, I thought, as if the market owes me an explanation. As it was, I had a decision to make at market close: sell my holdings for a loss or hold overnight. Clearly, I would lose with a last minute sale. An overnight hold would sometimes turn a profit the next morning, leading me to think I did something right and it was ok to function this way, when in fact, I just got lucky. Big difference. Conversely, if the market went against me, I would lose. When I finally recognized that the market moves in overnight with or without me in it, I got smart and decided to stop trading at about noon. If I couldn’t make money in the morning, I likely would not do well in the afternoon.

Two things happened with that revelation: I kept more of my earnings and I also gained back my afternoons to do other things in life. You see, there are two aspects to market success… making money and keeping it.

There are many aspects to the mentality of trading. This article just touches on a few but I want to bring your attention to three key emotions you absolutely must have total control over. Your ‘screen door’ must be completely locked against these mental gremlins at all times if you want to succeed. There is no avoiding it if you are serious about making money on the market.

We need to do everything humanly possible to minimize risk in trading. One bad trade can destroy a person and his family. It is imperative to tackle and hold down these three emotions.

Fear, Greed and Ego

Studies show that fear is the overriding emotion that makes traders sell their positions. You only need to observe any stock chart. Prices gravitate upwards but drop sharply. Money begets money. When demand increases, it attracts more money into the market and prices rise. Similarly, when prices drop and a selloff starts, often with the institutions, traders dump everything like a hot potato. Just watch how prices tank about three times as fast as they rise. Fear is a killer and often times, causes unnecessary sell offs that would otherwise be profitable trades.

It took years to overcome my fears. I even took this exercise outside the trading world, addressing my fears head on. For example, I was always afraid of heights. I would rather endure a root canal than to clean out the eaves troughs on my one story home using a ladder. So how did I combat this crippling weakness? I took flying lessons. Through it all, I endure the terrifying stalls, spins and spiral dives. I experienced forced landings with and without an engine, with and without a runway.

When I got my license, I was given a piece of paper that confirmed my courage, much the same as the wizard awarding the lion a medal in the Wizard of Oz for saving little Dorothy. As a bonus, I also gain a healthy dose of confidence… and intelligence along the way… what a deal that was!

Now when I trade, I see short term, medium and longer term scenarios. When I get compliance on all three levels, I use my intelligence to courageously enter a trade and approach the positon without fear. That guides me to profit.

Fear: conquer it head on.

Greed is a very compelling emotion that can lead to catastrophic results if left untamed. Traders who are normally the most generous, humble and giving people in their everyday lives turn into Jekyll and Hyde personalities when confronted with the stock market. When in a profitable trade, the tendency is to stay in longer and take as much as possible out of the position. Fair enough, except that at some point, the stock peaks and reverses.

Intellectually, all trader know that. Emotionally, it fails to register as the more a trader has, the more he/she wants. To inch up your gains has merit and in a bullish market (assuming you are bullish), why not? Take as much as possible. But you also know that markets can and do reverse quickly and unannounced.

What to do?  I am likely the guiltiest with greed. I use several mental tricks to combat this overbearing emotion.  First, I hide my account balance, knowing that these numbers are a distraction and can lead to poor judgment. For example, if my account shows $9,950 on a Friday afternoon, I may be tempted to enter one last positon to take $50 and ramp up my balance to $10,000 heading into the weekend. This divergence has cost me thousands as I enter trades for the wrong reason and without any regard to the proven strategy.

Another mind trick is to accept that many smaller, 6%-8% trades are much easier to attain than one 20% or 30% profit. If I cannot be happy with a modest gain… several of them in any given day, then I should rather seek the services of a therapist. Always remember that most people do not even have as much as a retirement savings account set up. Of those that do, most are getting a nominal 5% per year or less. That puts us day traders proudly above the norm.

Understand too that our humility will be well rewarded.  In fact, if you only seek a modest 5% per day net profit, you are doubling your money in one month. I have a trading plan spreadsheet that illustrates that using this modest, highly attainable system, one could take $1k into $100k in well under a year.

Greed: remain firm for steady growth and ignore what you ‘could have’ made.

Ego is the final temptation you must keep locked behind your screen door. Accept that no one knows who you are in this game, so any attacks on your account are not personal. You are only an account number with your broker. Accept that you have nothing to prove to anyone. Fellow traders will understand your predicaments; all others do not matter. They have no clue what it is like. Accept that losses are part of trading and that using tight money management techniques will ultimate save your behind, should you fall into a trap. Who you are matters not. There is only one reason to trade: profit.

Whether you earn 5% or 50% in a trade is irrelevant to anyone but yourself. Lose any need to better you last efforts; it’s the slow, steady income that creates long term wealth. I destroy greed by placing concrete sell orders as soon as I make a purchase. If I pick up 8% and the stock rises to a potential gain of 60%, I don’t care… congrats to those who took it higher. I’m good with my fair share of the market.

As a side note, studies show that the best traders are women with no male influence. Single women make the best traders, followed by married women and married men. The worst traders are the single young men, likely on the heels of hit movies like Wall Street and the Wolf of Wall Street.

The market eats those with egos. Park it the night before you start trading.

Discipline and patience are the main characteristics for successful trading. Knowing how to discern which is needed when is key. Even the famed investor, Warren Buffet, said all you need is a 100 IQ for successful trading. Clearly, those who can maintain clarity and calmness are the winners.

My experience is that discipline and patience are like muscles. Use it or lose it. Those who come from a military background appear to be the most disciplined traders. In fact, anyone who needed a strong sense of control to achieve their prior life’s goals make the best traders. Following rules, assessing risk and displaying a sense of will power to ‘pull the trigger’ are traits of a winner.

Like a muscle, it is good to exercise discipline and patience. For example, my fine German built automobile loves to go fast, only superseded by my desire to drive even faster. You can only imagine I have been unable to keep the speed limit since my driver’s test in 1971.  I have all the speeding tickets and insurance increases to prove it. However, as a strength and conditioning exercise, I took to the New York Interstate and, in a slow stretch of highway, I pulled into the right lane and held my car at the posted 65 m.p.h.  My wife was not amused so I do not do this with her anymore, but often times I will drive the posted speed limit to strengthen my discipline. It started with just one mile, now built up to a 10 mile stretch of highway. Of course, I only do this when there is no interruption of traffic.

Learning to cope on a slower speed of life does become easier over time.  You can extend this virtue to other parts of your life, including options trading.

Applying the Screen Door Mentality

I made a point a long time ago to knock out the negatives in my life. Stay positive, stay focused, surrounding myself with only people who exert a positive influence on me.

This is exemplified in my trading.

Using the winning methodology I developed for my own trading, and now teach others, I recently bought the SPY 218 next week’s expiration call options on August 31 for 1.19. The market turned on me. Through careful maneuvering, I bought more at .99, bringing my average buy price to 1.09. From a mental standpoint, most trader would have sold early on with the drop. After all, they were losing, right?

I don’t take losses very well anymore. Through my various inputs, I had every confidence still in the trade. The storm brought SPY down to .63, a whopping 42% drop, but I stuck with it. In fact, I got very excited at that moment, enticed by what was happening in the market. So much so, that I bought a higher risk, this week’s expiration 218 calls for .54, more at .40 to bring my average down to .47. I had every confidence this was to be an outstanding trade. That latter entry was on a Thursday during a Live Trading with the Pros session, shown mostly as a demonstration.

The irony of it all, I spent most Thursday afternoon pacifying our participants in their long positions.

But look what happened on Friday. SPY surged, pulling up all our calls with it.

The accolades poured in, but more importantly, those who stayed the course pulled in stunning profits.

Whether a trader takes a profit or loss has little to do with the actual market. It has everything to do with the mental approach to trading. The market does what it does. It goes up and it goes down. It is how you trade, how you control your emotions that affects your bottom line.

In this trade, I took my gains early on Friday morning.

Front week’s options went from .47 to .72 for a profit of 53%.

Next week’s options went from 1.09 to 1.34 for a profit of 23%.

The following were applied to this trade: discipline, patience, self-control, intelligence, confidence and courage. As well, my proverbial screen door was shut to the naysayers, those well-meaning souls destined to protect me from this momentary loser trade.

Feeling positive on the Friday, heading into the Labor Day holiday weekend, I took on another two positions, this time to the down side.

Again, following my strategy, I bought the SPY 218.50 put options expiring in a few hours for .22, at 10:02 am, selling a mere 7 minutes later for .30, yielding a profit of 36%.

One last trade at 10:48 on the SPY 218 puts for .81, out at .88 topped off the day for an additional 8%.

Total for the day: 120% profit…. and the best part: I was done before 11:30 am, leaving me the rest of the day to enjoy at the beach with my family and friends!

It is understandable how most people cannot fathom how these gains can occur. Instead, the mentality of the masses directs them to complex strategies involving high maintenance spreads, most of which do not approach the potential you can realize by keeping it super simple.

You can only lose if you sell for a loss. If you are losing, you still have opportunities to turn your losses into profits.

Below is the screen shot of the actual positions. Real trades, real people, real money.

The market will do what the market does. You cannot control prices, only your reaction to them. 

How you react will determine your profits and losses. Bear in mind that it is other traders you are trading and the winners are those who anticipate what the masses will do.

Once you understand the mind game in trading, how you relate to the stocks and to other traders, it is not that difficult making money in the stock market. The mental approach serves to minimize risk.

Above all, mind your ‘screen door’.

Head Trader/Trainer

Hugh Grossman

THE SPECIAL OFFER

Contact Hugh at  [email protected]  and mention this article for a free trial of our Live Trading with the Pros or a free e-book of your choice, valued at $149.  

ABOUT THE AUTHOR

Reduced Risk Covered Calls

There are several ways to reduce risk in covered call trading, and yet still make good monthly income. In this article we start with 79,062 covered call candidates for the September expiration and show how to reduce that set to 15 lower risk covered calls that still have an average annualized yield of 48%.

Covered Calls

Covered calls are a conservative income-oriented investment strategy. Anyone who owns 100 shares of stock can do a covered call. And many people do… online broker Charles Schwab has stated that 84% of their option-enabled accounts trade covered calls… which makes covered calls the #1 most popular options-based investment strategy among Schwab's customers.

Example Covered Call

Imagine you buy 100 shares of XYZ stock trading at $49, and you would be happy to sell your stock for $51 in a month. You could sell 1 call option contract that expires in 1 month and has a strike price of $50.

Let's say you receive $1/share for this call option contract. Because option contracts control 100 shares, you will receive $100 the day you sell this 1 option (and if you had 500 shares you would sell 5 contracts and receive $500). Your adjusted basis on the stock is now $48, because you paid $49 for the stock but you received $1 in option premium on the same day when you sold the call option.

Two things can happen on option expiration day in 1 month: XYZ can be $50 or less, or XYZ can be more than $50.

In the first case, where XYZ is below the strike price ($50) on expiration day, the option will expire worthless and you keep the $1/share premium you received. You also keep your shares, so you can sell another call option for the following month if you want (and repeat every month). Your basis is now $48/share.

In the second case, if XYZ is above the strike price ($50) on expiration day then the call option will be exercised against you (also called 'assigned' to you). When this happens you will forfeit your 100 shares of stock but you will receive $50/share in cash. So your total cash take is $50 on assignment, plus the $1 you got when you first sold the call option, for a total of $51. You've made $2/share profit on a $48 investment (your adjusted basis), which is 4.2% in 1 month. If you multiply by 12, that's an annualized rate around 50%.

Covered Call Risk

Like all investment strategies, you can choose to do covered calls in a conservative manner, or an aggressive manner. Conservative covered call investors choose stocks that are not super volatile, and stay away from things like earnings dates or FDA announcements. They seek large cap, dividend paying, blue chip stocks. And they don't trade on margin.

Aggressive covered call investors do the opposite… they seek stocks that have options with the highest possible premiums without regard for why those premiums are so high (eg. expected product announcement, or FDA announcement, or M&A rumors, or earnings announcements, etc). They trade on margin, and they trade thinly-traded option series (low open interest makes for wide bid-ask spreads and makes it costlier to do adjustments to the position should the need arise).

The Universe Of Covered Calls

Today, September 2, 2016, there are 421,834 covered calls available. That includes all strikes, all expiration dates, and all stocks and ETFs that trade on US exchanges.

Of the 4,445 underlying symbols, 3884 are stocks and 561 are ETFs (exchange traded funds, which are typically baskets of stocks like mutual funds).

If we look at the number of covered calls offered by expiration date (that is, all symbols and all strikes for a given expiration date), we find:

The 5 shaded blue rows are weekly options. The number of covered calls offered is less for weekly options than for monthly options because not all underlying stocks and ETFs trade weekly options. In fact, only 476 of the 4,445 optionable symbols trade weekly options. But they are most heavily traded 476 stocks and ETFs so chances are good that weeklys will be available for stocks you are most interested in. (By the way, weekly options are the same as monthly options except that most of them have fewer days until expiration. They expire every Friday for the nearest 5-6 Fridays, while monthly options expire on the 3rd Friday of the month and are available every month for at least 12 months.)

Open Interest

"Open interest" is the number of contracts that exist for an option series. If you want more liquidity and tighter bid-ask spreads then more open interest is better. If we look at the sum of open interest by expiration date, we can see there is more interest in the monthly options than the weekly options:

Reducing Risk

Now that we've established how many covered calls there are, and seen what kind of open interest there is by expiration date, let's find some ways to reduce covered call risk.

Start With 79,062 Choices

Let's focus on the Sep 16, 2016, expiration date where there are 79,062 different covered calls offered (all symbols and all strikes), and they have a combined open interest of 30.9M contracts right now. All of these options expire in 2 weeks.

Remove Leveraged ETFs

Not all ETFs are created equal. Some of them are designed to have 2x or 3x the daily movement of some other ETF or index. These are called leveraged ETFs. For example, NUGT is a 3x leveraged ETF designed to have 3x the movement of the NYSE Arca Gold Miners Index. If you want to make a short-term directional bet on the gold miners index then NUGT may be for you. But it is not good for covered calls.

The first thing we want to do is eliminate leveraged ETFs from the 79,062 covered calls. Turns out there are 5024 of them, leaving us with 74,038 covered calls to choose from.

Remove Low Price Stocks

It's really hard to make money in covered calls with very low priced stocks. Plus, the low price stocks are subject to more manipulation than higher priced stocks, and they can be quite volatile. If we define "low price" as $5/share or less, then we find there are 2216 covered calls in this range. Removing them leaves us with 71,822 covered calls.

Remove High PE Stocks

It can be tempting to invest in high-flier momentum or high PE (price/earnings) type stocks. They can make you a lot of money quickly as long as their growth and momentum doesn't stop. These stocks often trade at very high PE multiples but once their balloon is pierced and the market starts to value them more like other companies, their stock price can come down in a hurry. Examples include NFLX with a PE of 295, or AMZN with a PE of 187. These are good companies, to be sure, but consider that the average S&P 500 stock has historically traded at a PE of 15.

Turns out that 1311 underlying symbols have a PE > 20, and they represent 24,829 of our remaining covered call candidates. By removing these high PE stocks we're left with 46,993 options.

No Earnings Before Expiration

Earnings release dates are high volatility events and any option for an underlying stock that has an earnings release between today and expiration will be priced for earnings volatility. It may be tempting to sell these fat-premium options as part of a covered call but if the underlying stock makes a 10% move downward you are likely going to regret it. There's just too much risk around earnings for the typical covered call investor, so let's remove them.

There are 43 companies that have an earnings release before our chosen expiration date of Sep 16, 2016. They represent 614 covered calls. Remove them and we're left with 46,379 covered calls.

Remove Small Companies

Companies that have market capitalizations (aka 'market cap') of less than $500M are volatile. Many of them are new issues (recent IPOs), and the others have small enough market caps that a single investor can move the stock up or down.

There are 559 companies in our remaining set that have market caps of less than $500M, representing 7,820 covered calls. Remove them and we have 38,559 covered calls.

No Tiny Time Premium

Because of commissions and trading slippage, we don't want to waste our time with options that have little tiny time premium, such as less than 20 cents. If you are trading tens of contracts at a time then you might be able to relax this rule, but we're going to eliminate the 36,759 covered calls that offer less than 20 cents of time premium, leaving us with 1800 covered calls.

Remove Low Annual Return

Ideally, we would like to have at least 1%/month (12%/year) return in order to make our covered call investing profitable. If you're writing out of the money covered calls just to get some extra income from stocks you are hoping not to have called away then you can relax this rule a bit. But for our purposes, we're going to remove the 311 covered calls from our set of 1800 that offer annualized returns < 12%. We are now left with 1489 covered calls.

In The Money and Downside Protection

A call option is called "in the money" if the strike price is below the stock price. These options are likely to be called away if they are short term and there are no volatility events before expiration. "Downside protection" is a combination of moneyness (how far something is in the money) and time premium. It measures how much the underlying stock would have to fall before we'd experience a loss. Some of the fall is protected by intrinsic value (since the option is in the money) and some is protected by the amount of time premium we received when selling the option.

For our purposes, we're going to reduce our set to only those covered calls that have at least 5% downside protection. This reduces our set to 150 covered calls.

Higher Open Interest

As mentioned earlier, more open interest is better than less. It makes for more liquidity and tighter spreads, both good things. If we look at our 150 covered call set we see that many have very small open interest. Not good for us. Let's limit the set to only those with an open interest of 2000 contracts or more. There are 28 of these.

No Healthcare

Healthcare stocks are very volatile around FDA announcement time. That's when the FDA either approves or denies a company's new drug, device, or therapy for treatment on humans. Stocks can double or be cut in half, depending on how the FDA rules. These kinds of high volatility events are not good for covered call investors (too risky). So, we're going to remove all healthcare stocks from our set of 28, leaving us with 15:

The Final 15

Well, started with 79,062 covered call candidates and, by removing various risk elements, ended up with these 15:

How To Read This Chart

The above is a list of 15 covered calls. These are not trade recommendations. These are merely the only covered calls for the Sep 16, 2016, expiration that survived our risk-reduction filters.

Net Debit is your total cash outlay (per share) to enter one of these trades. For example, if you buy 100 shares of AAL at 36.55 and sell 1 Sep 16 expiration, 30-strike, call option for 1.85, your out of pocket cost (net debit) is 34.70 per share. On Sep 16 if AAL is above 35 then you will receive $35/share in cash and have made 30 cents on a $34.70 investment in 14 days, for an annualized return of 22%.

Covered Call Screeners

Searching and filtering for covered calls is incredibly time consuming if you don't have software to assist. Fortunately, there is an award-winning covered call screener available at https://www.borntosell.com. Voted Best Trading Software 2 years in a row.

THE SPECIAL OFFER

We have created a special offer for Born To Sell's covered call screener. Not only will you get 2 weeks free (with no obligation to pay anything if you cancel within the first 14 days) but you will get additional free bonus months depending on the length of subscription you sign up for. You could get 1, 2 or 4 months free for a monthly, quarterly, or annual subscription.

ABOUT THE AUTHOR

MAKE YOUR OWN LUCK

Before jumping in please allow me to take a few monuments to discuss a few key concepts to achieving trading success.

Don’t Copy! 

When learning a new trading pattern or setup from another trader it’s natural to think if I copy, I should have the same results.  I wish it were that easy!  Hand the exact same chart to 10 traders and ask them for an analysis and you will receive 10 different answers.  We all see things a little differently based on our individual knowledge and experience.  To be successful don’t copy but make it your own.  Develop your own set of rules that fit your individual trading style and risk tolerance and watch your results improve.

Keep it Simple. 

We live in a world of instantaneous news and most charting platforms are loaded to the gills with indicators.  While all this technology is great, it’s very easy for traders to get so bogged down with data they forget to look at the most important indicator of them all.  Price!  In fact, I believe price action is so important that my most used chart is a Naked Chart, where price is displayed without the distraction of other data.  I’m not suggesting you should never use an indicator but before you do, study the price action.  Charts used thought-out this book will us my simple black and white Naked Chart, provided by TC2000 a product of Worden Brothers.

Plan your trade and trade your plan.

Without question the #1 mistake I run into as a trading coach is trading without a plan. A well thought out trade plan puts you in control of your emotions rather than letting them control you.  All good plans start with an achievable goal.  Does the trade in consideration have the potential to reach the goal you set?  That’s important to know!  Each and every trade should be planned with and entry, stop and targets to capture gains.  This information is essential to understanding the risk and the size of the position that’s acceptable to your individual risk tolerance.  Let’s face it, trading is not easy, so don’t make it harder by allowing poor emotional decision making into the mix.  Your business deserves better.

POP OUT OF THE BOX

The Pattern 

A simple eyeball scan is the easiest way to find the pattern because it comes in many different shapes and sizes. What  you are looking for is nothing more than a tight range consolidations of Dojis and spinning tops that occur with a trend. Placing a box around the pattern should easily define the bottom of the range as well as the top of the range.

The Setup

This pattern requires a little patience while you wait for the pattern to develop but by doing so the trader is rewarded with a very-low-risk entry for either a stock or option position.

During the consolidation period, the Implied Volatility will normally decline to provide an opportunity to purchase options at good prices.  When the price pops out of the box, Implied volatility will normally begin to increase adding some extrinsic value to an already profitable position.

By placing an alert at or just above the box can provide a very efficient entry while the stop loss can be placed just below the box creating a very low-risk trade. 

UP TRENDS AND DOWNTRENDS

Make the Trade Come to You

Because the breakout or breakdown can occur at any time and in any market condition it is important to follow the price action rather than attempting  to predict.  When I find this pattern potentially forming within a trending chart, I simply create alerts, put the chart in a watch list, and forget about it until the alert triggers.  Time is precious, so why waste time to stare a chart that may or may not move?  By setting the alert and waiting for it to trigger I’m making the trade come to me rather than me rushing into a position not properly planned.

Keep in mind that breakdowns can create violet price movement with significant increases in Implied Volatility.  If you miss the trade it’s wise to just move on to another trade rather than chase into a position with increased risk due to the higher IV.  However, the trader correctly positioned with put options at the point of breakdown will obviously benefit from the rising Implied Volatility.

Can’t watch the market during the day?

If you’re not able to watch the market during the day obviously setting a price alert does you no good when trying to trade the pop out of the box pattern.  Not to worry!  With the use of advanced brokerage orders, you can trade this pattern with confidence.  I know because I traded this way for years while I was building a trading account and still punching the clock.

In the chart above, the green box on the left has a high of $37.28 and a low of $36.63.  To trade this I would make use of a Stop / Limit order for the entry.  The stop portion of the order can be thought of as the trigger price while the limit sets the maximum you are willing to pay.

Example: If I wanted to buy a stock just as it crossed above the box I would set the buy stop at $37.29 so as soon as the stock crossed up the order could be filled.  The limit I would set about $0.25 higher at $37.54.  This would allow for a fast moving market and still get me into the trade without having to worry about the stock gapping up big and getting me filled with a substantially higher risk of being stopped out.   I would combine the entry order with an OTO order (One Triggers Other) to establish my stop loss.  When the entry order was filled my stop loss order would be automatically entered to protect me from losses I had not planned for.

Making use of these advanced orders I was able to effectively trade without access to the market during the day.  I could place trades and manage positions with a very mechanical methodology without involving my emotions.  But what about an options trade?

ADDING A CONDITION

In the example, on the last page, rather than trading the stock we have decided we want to use options to enter the position.  To make that happen all we have to do is add a condition that allows us to buy or sell an option based upon the price of the stock.

So let’s say we have selected the 35 Strike ITM options for this trade.  Using a conditional order we would instruct the broker to buy the 35 strike option, if and only if, the stock trades at or above trigger price of $39.29.  The OTO stop loss order would, of course, also be conditioned to the price of the stock automatically selling the option if or when the stop price is violated.

The options trader could also use the stop / limit entry order based solely on the price of the options traded.  However, that requires a good understanding of the options pricing model to accurately determine what the market price of an option would be at the specific stock entry triggers.  Your brokerage may have tools and resources available to you making advanced order placement a snap.

Learning Advance Orders

I highly recommend contacting your broker as soon as possible to learn how to, place advanced orders.  Knowledge is power, and the more you know about the tools available to you the better equipped you will be to develop and maintain your Edge in the market.

Buyer Beware

Just because options are offered on a particular equity it does not mean they are suitable to for trading.  Wide Bid / Ask spreads are often a clue that the options are illiquid or that Implied Volatility is abnormally high due to an expected news event. Unknowingly entering into a bad position from the get go is a lesson you don’t want learn the hard way.  Your due diligence is mandatory!  Know what you're buying or suffer the consequences!

THE WHO AND THE HOW

The aggressive trader will see the Pop out of the Box pattern as a simple directional trade.  Using simple calls and puts as a replacement for the stock the trader seeks maximum results from the directional move.

Although OTM options provide tremendous leverage it’s the ITM options with a Delta between 70 and 80 that provide the best bang for the buck as a stock replacement strategy.  Make sure to plan adequate time for the stock to make the expected move before Theta becomes a major factor affecting the contract price.

The Moderate trader has a directional bias with a slightly neutral stance to the Pop out of the Box Pattern.  Using a Debit Spread takes advantage of the directional move while lowering the cost and the overall risk of the position.

Choosing to buy an ITM strike with a Delta between 70 and 80 effectively captures the directional move while selling the OTM strike with a delta near 30 neutralizes some of the risk and lowers the cost.

The Conservative trader see’s the Pop out of the Box Pattern with a passive, income generation eye.  Using a Credit Spread capitalizes on the Theta decay of the options while still taking advantage of the patterns directional nature.

A front month OTM credit spread that collects approximately 1/3 of the spread in credit fits nicely as passive income and maximizing Theta decay.

Clearly, the above examples are only a small sampling of the possible strategies that an option trader may employ to derive profits from the Pop out of the Box pattern.  No matter how you choose to trade this pattern, carefully planning the trade is essential for success.  An unplanned trades invites emotion into the trader's decision process.  In the heat of the moment, emotion decisions involving money rarely end well.

Thinking longer term than a swing trade?          

I love swing trading but there are times holding a trade a little longer really makes a lot of sense.  The Pop out of the Box Pattern on weekly charts will obviously show up less frequently than it will on short term charts…however when you do find them the results can be outstanding.  The weekly chart will also eliminate a lot of the price action noise normally associated with the shorter term charts making the big trends very easy to see.  In the chart below there are several easy see Pop out of the Box Patterns offering up weeks of uninterrupted gains.

Planning a longer trade with options?

A great strategy to employ with the longer term position is the covered call for the more conservative trader.  You can often string together several months of fantastic covered returns.

For the more aggressive trader straight call and put, positions can easily offer up triple digit returns.  It’s very important when considering a longer term directional position to plan sufficient time for the expected move.  I generally will plan 3 to 6 months into the future depending on the contracts available with the idea of taking profits at least 30 days before expiration.

ESTABLISHING TARGETS USING SUPPORT AND RESISTANCE

In the chart above you can see my simple trade plan to capitalize on a very tightly formed Pop out of the Box Pattern.  Every trade I make is planned around support and resistance levels and has a minimum profit goal.

My first target must always have the ability to reach my minimum profit goal or I pass on the chart.  I size the trade in such a way to scale out of the biggest part of the position at Target 1, banking my goal profits.  Take note that Target 1 is the level I identified as the next resistance where the stock could easily stop or reverse.

With the trade goal profits safely in my account, the pressure is off the position and all I have to do is manage the remainder of the position.  I can give the stock time to pullback, consolidate and simply wander as all stocks will do.  I, of course, adjust my stop to break even or better but now letting the trade run has little to no emotional affect.  In the example above the stock alone had almost 11% gain to target 1 and over 16% to target 2.  Option profits on this same trade are substantially higher percentage wise.

The Trend is your Friend

The Pop out of the Box Pattern loves to form in stocks within a trend both up and down.  Watch support and resistance zones where price may stall and rest to gather energy for the next move.  In the first few days of this pattern, it’s common to see a slightly wider range of daily price movement but as it spills volatility the price range can tighten significantly.  Typically you want this pattern to be least 4 days at a minimum to allow the pressure to build for a break with momentum.

INDICATORS – KEEP IT SIMPLE

Although I rarely use indicators it is unrealistic for me to assume that everyone would want to trade with such a simple style.  For you that can’t image a chart without indicators I would like to suggest to you to keep it simple or you will likely miss the pattern altogether.  In the GPRO chart below I have marked the pop out the box pattern with the light green boxes but I have also added 3 exponential moving averages.  The 34 EMA is there to display trend or the change thereof.   The 3 EMA and the 8EMA show you the momentum of the move and will provide an early warning to a possible reversal.  At the beginning of the downtrend notice the clear cross of the 34 by the 3 and 8 averages.  On the second pattern that the 3 and the 8 squeeze together tightly but the 3 fails to cross over the 8 confirming the downtrend and the pattern failure are valid.

In the chart below the 3 and 8 cross showing the beginning of an uptrend confirming the breakout of the pattern.  The second pattern clearly shows a moving average squeeze with shorter averages unable to break below the 34 average providing confidence the pattern will likely resolve with an upside breakout.  Due to the length of the pattern take note of the extra shot of momentum created when it pops out of the box.  Sweet profits!

THE SPECIAL OFFER

Did you know you do not have to sit in front of your computer all day? You can even have a full time job, yet still trade and make money! We have so much to offer when it comes to Swing Trading and Options.

ABOUT THE AUTHOR

One of the most common mistakes people make is confusing low-risk and high-probability.  There are lots of trades out there that have a high-probability of returning some profit and/or winning.  There are a lot of trades that have low-risk.  There are very few high-probability, low-risk trades.  There are even fewer high-probability, low-risk trades that will produce any type of high return.  Most traders have a better shot at finding Jimmy Hoffa than they do a trade that is low-risk and has a high return.  They think they have a low-risk, high- return trade, but what they have is a high-probability trade with a decent return profile.  So what is the difference between the two, and how can you spot a high-probability trade dressed as a low-risk trade?  Let’s discuss by first describing the difference:

High-Probability Trades

A trade that has a high-probability of making money or breaking even is a high-probability trade.   Think of a bet that allows the gambler to pick both red and black on a roulette wheel, but loses if it lands on the green.   On its surface, this bet sounds like a great deal, one gets to win 36 out of 38 times, almost 95% of the time.  But how much would this bet cost?  What would the payout be?  My guess is that with an expected win rate of 94.74%, the bet would be at least 96.00 to win 100,  really 96.00 to win 4 dollars.  Let’s recap this trade:

Trade wins 94.74%

Trade Pays 4.00

Trade Costs 96.00

If this bet was executed 100 times, the bettor would be out 1.26 statistically.  Thus even though this bet has a high-probability it is actually NOT low-risk, because one is expected to lose.  Thus, a high-probability trade is nothing more than something that wins most of the time, not something that actually makes money.  Which I why I present to you the 1st rule of due diligence:

1. DO NOT TAKE WIN PERCENTAGE AS A VALID STATITIC ON ITS OWN.If someone claims a high win percentage, ask for standard deviation of the portfolio, for a peak to trough, a Sharpe ratio, and preferably a Sortino ratio and his or her expected return.EXCEPTION:track record exceeds 25 years.

So what is an example of a high-probability trade that might not make you money if you don’t do it right?  A Strangle.  When executed well, with knowledge and understanding, strangles can be an extremely effective, income-producing vehicles.  However, the risk/reward on them, when one is wrong, can be deadly.  Take a look at the strangle from September of 2016 on the next page.  It had a nice pay out at expiration, but if the market drops or rallies significantly it can lose big. 

While a big outsized move is unlikely, it can happen in a flash.  Even when the underlying recovers it is usually AFTER the margin call.  Take a look at how this trade would have gotten pounded as recently as June.

A strangle traded ahead of June would have blown out the trader, on margin alone.   Even though it has a high chance of winning, it doesn’t mean the payout is good, which means it is a higher-risk trade.

Low-Risk Trades

Low-risk trades are generally unexciting. They may not pay much, but they also do not lose often.  For instance, a zero coupon Treasury bond has very little chance of losing money if held to expiration.  It has a set duration and has a set pay out.   Basically, there is no way the investor is not getting his or her money back.

Now, while the risk is low, so is the return. Right now the return on the 10 year note is about 1.7% per year, less than inflation.  However, there is no way the person that hands the US Treasury 10,000 dollars for a bond does not give their money back.  This is the definition of low-risk.  At its extremes, low-risk trades have little return.  While the mattress might be safe, it also presents little return. 

Additionally, sometimes low-risk trades can become crowded.  In 2008, a few money market funds, which are often viewed as cash almost, blew up.  There have been Muni bond explosions in districts that were low-risk; there is currently huge risk in government bond funds.  ETF’s like IEF and TLT which hold government securities and supposedly have low-risk have seen some serious run ups and in September of 2016 saw some serious volatile.

The point is that just because something has low-risk, does not mean it has NO risk.  Low-risk means that likelihood of losing A LOT of money is low. However, losing money is not impossible especially if the trade is structured poorly or mishandled.

Basically, if one gives their money to someone for a low-risk trade and they do not know what they are doing, it could be more risk than one realizes.  If one does not know what to do if a low-risk trade moves against them, it also is a problem.

RISK RULE 2:  Make sure you and the other side agree on what ‘low-risk’ really means.

So what is a real low-risk option strategy?  A collar trade in a high dividend stock.   In a collar the trader buys a stock that pays a dividend, buys a downside put to pay for it, then in the same contract month sells an upside call to finance part of the put purchase.  See XLU below:

Risk Adjusted Return

The key to finding the right trade is to ‘risk adjust the trade.’   In doing this the quick, dirty and simple calculation is trader takes the expected return of the trade and then divides it by the standard deviation.  Let’s compare two trades:

Trade 1:  Return 10%  StDev .12  Risk adjusted return .10/.12=8.33%

Trade 2:  Return 12% StDev .14 Risk Adjusted return .12/.14=8.57%.

While this is a ‘back of the envelope’ calculation it will do the trick for most traders that need to make quick decisions between two trades.

Lower-Risk Trades We Like

We always like hedged trades.  However, the best trade right now is what we call the double short.  In this trade we play the market short volatility by using VXX options.  Against this we use SPY to hedge the trade. 

In this trade, we buy a put spread in SPY and a put spread in VXX at the same time, on a ratio.  The idea being that short volatility in VXX tends to pay. If you don’t believe me, take a look at a chart of VXX over time:

While the ETP has lost about 100 dollars over the last two years (split adjusted), the stock can have pops.  To hedge this, we buy a SPY put spread to pay for it. The standard hedge will be set up so that if 1 SPY spread goes in the money half way between the long and the short, the spread will pay for 3-5 of the VXX put spreads.

Here is a recent trade we took:

We buy 10 VXX Oct 39-34 Put Spread for 2.30

We buy 4 SPY Oct 210-200 Put Spread for 1.90

THE SPECIAL OFFER

This is a trade we do all the time in our chat room which you can join for just 17.00 dollars today. 

There is no better service that one can try at such an inexpensive price, yet provide such an immediate impact on successful trading.   If you don’t take action right now, my one month trial of Option Pit Live for Just $17 dollars is going to slip through your fingers.

Normally we would sell Option Pit Live at 125.00 a month.   You can view our pricing and structure on our membership page.  You get it for 17 for the 1st month to dip your toe in the water.  We will prove to you that you can be successful with us.

Take just a few minutes to review this unpublished offer.

Option Pit Live comes with the

• Live access to our special Saturday Classes, like the VIX primer,Condors and Butterflies, and Weekly Options trading
• Option Pit Strategy letter our daily newsletter full of actionable trade ideas and important market analysis.
• All day access to the Option Pit Chat Room
• Unfettered access to me and Option Pit’s other professional traders, not to mention a host of other student traders that are full of great trading ideas.

I implore you to take advantage this offer as once as I am not going to offer you this price again. Enjoy Full Membership with a 30-day trial of only $17!

ABOUT THE AUTHOR

There are many Low Risk trading strategies for options, and today I’m going to discuss just one very simple trading strategy for the beginner options trader.

My name is Tony Sizemore from Option Elements. I’m a full time professional options trader.  I trade my own money and I manage accounts for others. The following is a short video that will provide you with a glimpse of one way that the professionals earn monthly income trading options.

The good news is you can learn to trade options like the professionals in a relatively short period of time, provided that you do not attend the school of hard knocks.  There are a few capable professionals out there whom you can learn from, and our website is one of them.

Please take a look at the following short video on Condors and Butterflies. At the end, you can click the link to get more free information.

THE SPECIAL OFFER

Low Risk Income Options Trading for the Intermediate Trader

As an intermediate options trader, you are familiar with the basic trade types such as Condors, Butterflies, Calendar Spreads etc.  But now you are ready to move into more deliberate designs which can address specific aspects of the options Greeks.

Take a look at the following 5 FREE in depth training videos:

• Option Combination Strategies Free 1 - hour class
• Weekly Options Class Free
• Condors & Butterflies Free
• Diagonal & Calendars Free
• $10k Weekly Portfolio Free

ABOUT THE AUTHOR

Every trader has a different trading personality. Some like volatility while others don’t. Some like to trade the action on Opening Bell while others avoid it or simply can’t due to work considerations.

Trading Forex pairs with binary options and spreads provides multiple opportunities for traders who love volatility, and for those who don’t. In the eBook “Best Times to Trade Currencies”, Josh Martinez with MTI divides the Forex trading day into two distinct zones: 

Active Zone (2am – 12pm EDT) 

This is when the Forex markets are likely to be most active. 

• - 2:00am EDT:  The European financial markets open
• - 3:00am: The London Financial Markets Open
• - 4:30am: This is a very common time for High Impact News Releases out of the UK
• - 8:00am: The New York Financial Markets Open
• - 12:00pm : The London Exchange closes

During Active Zone, large volumes of financial transactions occur, especially after the open of the London Exchange at 3am. There is the potential for strong volatility, and it can be accelerated on economic news reports out of Europe and the UK , usually between 3-5am. 

At 8am, the New York Exchange opens, adding more fuel to the fire. During the Active Zone, there can be large swings in many currency pairs to the upside or to the downside.

The Active Zone is where pips are collected. If you like to trade spreads, you can capitalize on large potential moves, especially after the London Open at 3:00 am EDT. If you have a strategy for trading spreads, and you are on the right side of the market, you can have a very nice trading day in just a few hours. 

There is also the opportunity to lose nearly as much if your on the wrong side of the trend.You can also trade binaries on the Active Zone. As the market dives or climbs between 2-5am EDT, you can BUY or SELL binary options going with the direction of the trend.

Dead Zone (12pm – 2am EDT) 

The Forex markets tend to quiet down as the European and London Exchanges close, and the New York Exchange starts to wind down after lunch. The volume of transactions being cleared slows down dramatically, and it’s not uncommon for the market to start drifting sideways, with little movement to the upside or to the downside. While the Dead Zone is not normally an ideal time frame to collect pips, it can provide attractive opportunities for trading binary options.The Dead Zone is no time to trade spreads. There simply isn’t enough volatility to collect any meaningful pips. 

But the Dead Zone offers prime opportunities to trade binaries.  Shortly after the 12:00pm lunch hour in New York, volatility leaves the market with several popular currency pairs in the US and Europe, including the GBP/USD, EUR/USD, USD/CHF, and others. If you can stay on the right side of the market going into the Dead Zone, then there can be multiple opportunities to place in-the-money binary trades, risking $70-$85 per contract. While this may seem like a lot to risk, your probabilities of a successful outcome are also very high.Tuesday, April 5 was another textbook example of the potential for trading Active Zones and Dead Zones on the GBP/USD:

Active Zones vs. Dead Zones

This 15 minute chart shows a fairly typical trading day on the GBP/USD:

• - Before 2:00am EDT: The market quietly chops sideways before the European Open
• - 2:00am EDT: The Euporean Market Opens and the GBP/USD starts to dive.
• - 3:00am EDT: The London Exchange Opens, further acceleration to the downside
• - 8:00am EDT: The New York Financial Markets open. Market starts to reverse
• - 12:00pm EDT: The London Exchange Closes
• - 12:00pm-2:00am: The Dead Zone begins. Very low participation in the market and low volatility.

The "See-Saw" Effect

Joshua Martinez also observed that the GBP and many of its associated currency pairs display a very predictable behavior, which happens quite frequently:

• - The Low or High of the Day will be established between 2am-5am EDT
• - The opposite High or Low will usually be established between 8am-2pm after the New York open

The hourly chart above shows 5 consecutive days of the GBP/USD. Can you see how the daily low or high normally reveals itself before 5am?

I view it like a "see-saw", with the hours of 5am-7am acting as the fulcrum.

If you see this pattern happening, then you have a very binary decision. If you see a high established between 2am-5am, then the probabilities are against that high being taken out for the rest of the day.

Does this pattern happen every day? The simple answer is no. If the GBP/USD chops sideways during the morning and there's no clear direction, then it's best to sit on the sidelines. Sometimes both the low and the high of the day occur after 8am. Any high-impact economic news released in the afternoon, like a BOE announcement or FOMC statement can violently move the GBP/USD in one direction or the other.

The 12:00pm Reversal

If the GBP/USD is on an extended uptrend or downtrend throughout the day, it is not uncommon for the market to reverse, at least temporarily for 20 minutes to an hour or more.

This chart dramatically depicts the 12pm reversal. The GBP/USD had been on an extended daily downtrend. At 12pm, when the London Exchange closed, the market reversed for one hour.

This 12pm reversal does not happen all of the time, but it happens often enough that it worth keeping an eye on the GBP/USD to look for this reversal opportunity.

What Can You Do With This Information?

Trading the Active Zone (2am-12pm)

This is a prime opportunity to collect pips. There are several ways to trade the morning move on the GBP/USD:

1. Nadex Spreads - If you get up early enough, you may be able to trade a Nadex spread and  catch a major portion of the early morning uptrend or downtrend, which often exceeds 50 pips.

Nadex Spreads resemble traditional Forex and Futures trades in that every pip collected is worth $1 per contract traded. What makes Nadex spreads different is that you are trading inside a "box" that has a defined floor, ceiling and side walls. Both your maximum risk and your maximum reward are known in advance of the trade.

• - If you are a BUYER, your maximum risk is the difference between your entry price and the floor of the box.
• - If you are a SELLER, your maximum risk is the difference between the ceiling of the box and your entry price.

Here's an example of a spread on a reversal of the GBP/USD:

The depth of this Daily spread box was 500 pips, or $500 per contract traded. 10 contracts were traded.

• - The Maximum Risk was $183 per contract, or $1,830
• - The Maximum Reward was $317 per contract, or $3,170
• - The Stop/Loss Target was 25 pips, or $250
• - The Take Profit Target was 50 pips, or $500

Within 2 hours the market dove 62 pips before reversing at the 200 SMA for a $620 profit.

Nadex Binaries and the Active Zone

• - In-The-Money (ITM) Binary Options: If you have correctly identified the Daily Low between 2am-5am, then you can BUY the GBP/USD within a time expiry you are comfortable trading. This is a high probability trade, and you will have a higher risk premium, like risking $70 per contract to make $30. 
• - Out-Of-The-Money (OTM) Binary Options: If you are a BUYER at the beginning of the morning move, then you could BUY an OTM binary option at a strike price several strikes above the current underlying price. Your risk could be $30 or less for a maximum reward of $70 or more.

Trading the Dead Zone (12pm - 2am)

When the London Financial markets close at 12pm EDT, the volatility in the GBP/USD quiets down dramatically. This is NOT a time to collect pips for traditional Forex trades or Nadex Spread Trades.

The Dead Zone can be an excellent opportunity to trade In-The-Money (ITM) binary options if you are on the right side of the market. 

Here's an example:

The GBP/USD chopped sideways after 12pm. Once the MACD crossed over and Stochastics started to dive from an overbought area, the decision was made to SELL from a strike price ABOVE the underlying market. There was a maximum risk on this trade of $76.75 for a maximum reward of $23.25, per contract traded.  With very little participation in the markets in the final hours of this trade, the market drifted safely to expiration at 7pm.

A Full Day of Trading on the GBP/USD

The GBP/USD offers daily opportunities for traders who like volatility and for those who hate volatility. If you get up early enough, there can be many opportunities to pick up 50 pips or more. If you are looking for high probability trades in the afternoon and early evening when the markets quiet down, there are also trading opportunities.

THE SPECIAL OFFER

ABOUT THE AUTHOR