Internationally Syndicated Article

Although it’s always been this way, it’s much more important in today’s markets to be a 

“Diamond Miner”. 

Volatility is the name of the game and in order to trade and / or invest in options on stocks, commodities, currencies and ETFs with consistent success, a trader must follow a well laid out plan.

On a weekly basis, one must scan (mine) many stocks, commodities and currencies based upon various criteria.  When potential "diamonds" (stocks, commodities, currencies or ETFs worth looking further into) are located / pinpointed, you need to put each and every one of those selected issues "under a microscope" (as a diamond cutter would do with a fine stone). 

The successful trader runs the potential “diamonds” through a qualification process in order to thoroughly "screen" each issue that passes this rigorous test:

-Note the direction of the overall market – obviously you trade differently in an overall bear market than you would in an overall bull market. Bullish = look to trade call options / Bearish = look to trade put options. If the market is moving sideways, that’s a different strategy which is beyond the scope of this article.

-Look at the sector that the selected stock or ETF trades in – is it bullish or bearish? 

Once again: Bullish = look to trade call options / Bearish = look to trade put options.

-Look at each candidate in several time frames (monthly, weekly, daily, and if necessary, hourly) – you don’t need to go down to the 15 minute charts for this type of trading analysis.

-Utilize at least two different online charting services to gain further perspective.

-Look at a maximum of 3 technical indicators.

Important Note:

Beginning traders often utilize too many indicators, which is a mistake. When utilizing too many indicators, many times conflicting trade signals are given, making a tough job even tougher. 

Other times, similar indicators are used, only to give an unnecessarily redundant message.

When this happens the trader experiences PBA (Paralysis By Analysis), because each and every indicator (when using many) will never agree – and the novice trader is looking for {non-existent} certainty in the uncertain environment of the financial markets. 

Be Aware: 

There’s no such thing as certainty in the markets – once you’re certain of a price move, it’s already occurred and the profit opportunity is lost. Learn to complete a thorough analysis and have the confidence to embrace the uncertainty (there will always be some uncertainty as there is no such thing as a sure thing when trading the markets) – and then execute (take ACTION) on your plan!  

Before taking action, however, a trader must further refine the process as described below.

Once all of the above has been screened and has met your stringent approval process, you need to take it a couple of steps further:

-Go to the trusty Option Chain found on many charting websites as well as brokerage websites.

-Note Open Interest / OI (you don’t want to be in a pool with very little “water”) – you want to only trade liquid option contracts. If you’re only trading a few options, OI of as little as 20 open contracts is acceptable, but when you’re trading dozens of contracts, you want OI of at least one hundred contracts or more. When trading a lot of contracts, you can also select various Expiration Dates as well as various Strike Prices.

Also, since option traders are generally the most savvy traders participating in the markets, it behooves you to watch what they’re doing. If you see that the OI on call options on XYZ stock is far greater in number than the OI on put options on XYZ (for the corresponding expiration and strike price), chances are these “in-the-know” professional traders and hedge funds, are positioning themselves to profit from what they anticipate as the future movement of the stock – and they are right about 80% of the time – an odds play in the markets that I’ll take any day of the week!

-Note the bid/ask spread (too wide a spread indicates potential illiquidity – too much of a spread means the option in question might not have the “action” you’re looking for when trading). There will always be a bid/ask spread – as with paying commissions - it’s just a part of doing business that you learn to live with.

-Option premium (must be reasonable when compared to the strike price and expiration date). 

This is something you “get-a-feel-for” with experience. Generally, the more “in-the-money” options you buy, needless to say, the more expensive they are and the less LEVERAGE you have on the trade. An “at-the-money” (market price is the same as your selected strike price) or slightly “out-of-the-money” option usually gives you the best “bang-for-your-buck”!  You’re looking for relatively quick price movements, so purchase between 2 – 4 months out expiration dates.

Also, with option pricing, timing really is everything:

In an up trending market, you would look to buy call options once a pull back (against the up trend) is completed, as the volatility (and corresponding premium / price) has also declined.

In a down trending market, you would look to buy put options once a bounce (against the down trend) is completed, as the volatility (and corresponding premium / price) has also declined.

All of the above are components of the overall trade Risk Factor*, which, when combined with proper Risk Management (total risk per trade and percentage of account size), makes up an excellent trading system.

So basically, from the scan to the actual option purchase, is a process of finding the "diamonds-in-the-rough" that have the highest likelihood of producing large profits (after putting them through the above process).

Once the trade is placed, you monitor the ensuing behavior of the selected stock and take your profits if your analysis was proven by the markets to be correct – or – quickly liquidate for a small loss if your analysis was proven by the markets to be incorrect.

It takes a lot of time and effort, but always proves well worth it!

This process applies to both the long side as well as the short side of the markets. 

Once many of the issues in most indices begin trading above their 30 week Moving Averages, any and all pull backs / corrections are viewed as buying (really call option purchasing) opportunities.

Once many of the issues in most indices begin trading below their 30 week Moving Averages, any and all bounces / rallies are viewed as short selling (really put option purchasing) opportunities.