Trading Stock Options Against the Trend
When you first realize it hits like a ton of bricks.
So simple yet so true.
About 80% of stocks follow the trend.
We all know the "the trend is our friend".
Can you smell a contrarian in the wood pile? Well, if 80% of stocks move with the trend that must mean that only about 20% of stocks or options will move against the trend on a normal day.
There must be a way to use those favorable odds.
And with options, there is.
An option trader can take advantage of this knowledge and use it to make a profit against the market trend.
The trader can write (sell) an out-of-the-money put.
This is also called a "naked put" because the writer does not own the underlying stock (it doesn't mean the option must have been written in a state of undress).
If the price of the stock goes up-as is expected-the trader who writes (sells) a put will keeps the writing premium just as long as the price does not go down below the strike price and into-the-money.
Given that 80% of stocks move with the trend, the probability of the stock moving against the trend and the writer can be very small.
However, to make this sort of trade, the trader needs to have a good understanding of what the short and long term trends are and if there is any possible news (earnings reports, adverse news, etc) that might send the stock reeling backward.
This is one of the more risky strategies because if the put goes in-the-money and the option is called, the writer must purchase the underlying stock to place with the option buyer.
A much safer way for an option trader to make money going against the trend is to write a covered call.
If the underlying stock is owned by the trader (thus, the put is "covered" in case it is called away), the option call writer is hoping that some other trader believes that the underlying stock will go up in value as will the derivative option.
But if the owner knows his stock very well and believes that its usually docile behavior will keep it away from reaching a certain strike price, the call writer will make money when the option expires if it doesn't get into-the-money and get called away.
For example, if the long term trend is up but the shorter term trend is in a correction phase, the trader can write the covered call with an expiration date that will fall within a time frame that should see the correction move back toward the long term trend.
Using the promise of a substantial move upwards into the money, the call writer hopes to lure in a trader who doesn't understand the stock as well as he.
Once the option expires, the call writer keeps the premium and if things still look good, (not much upside movement) he prepares to do it again, and again and again.
Given that there are option expiration dates for almost every month, the return can be quite impressive over the long term.
If a covered call writer is unlucky and his stock gets called away, well he gets to keep the profits and the premium.
The only thing he might lose is the opportunity cost of a large move in the underlying stock.
So simple yet so true.
About 80% of stocks follow the trend.
We all know the "the trend is our friend".
Can you smell a contrarian in the wood pile? Well, if 80% of stocks move with the trend that must mean that only about 20% of stocks or options will move against the trend on a normal day.
There must be a way to use those favorable odds.
And with options, there is.
An option trader can take advantage of this knowledge and use it to make a profit against the market trend.
The trader can write (sell) an out-of-the-money put.
This is also called a "naked put" because the writer does not own the underlying stock (it doesn't mean the option must have been written in a state of undress).
If the price of the stock goes up-as is expected-the trader who writes (sells) a put will keeps the writing premium just as long as the price does not go down below the strike price and into-the-money.
Given that 80% of stocks move with the trend, the probability of the stock moving against the trend and the writer can be very small.
However, to make this sort of trade, the trader needs to have a good understanding of what the short and long term trends are and if there is any possible news (earnings reports, adverse news, etc) that might send the stock reeling backward.
This is one of the more risky strategies because if the put goes in-the-money and the option is called, the writer must purchase the underlying stock to place with the option buyer.
A much safer way for an option trader to make money going against the trend is to write a covered call.
If the underlying stock is owned by the trader (thus, the put is "covered" in case it is called away), the option call writer is hoping that some other trader believes that the underlying stock will go up in value as will the derivative option.
But if the owner knows his stock very well and believes that its usually docile behavior will keep it away from reaching a certain strike price, the call writer will make money when the option expires if it doesn't get into-the-money and get called away.
For example, if the long term trend is up but the shorter term trend is in a correction phase, the trader can write the covered call with an expiration date that will fall within a time frame that should see the correction move back toward the long term trend.
Using the promise of a substantial move upwards into the money, the call writer hopes to lure in a trader who doesn't understand the stock as well as he.
Once the option expires, the call writer keeps the premium and if things still look good, (not much upside movement) he prepares to do it again, and again and again.
Given that there are option expiration dates for almost every month, the return can be quite impressive over the long term.
If a covered call writer is unlucky and his stock gets called away, well he gets to keep the profits and the premium.
The only thing he might lose is the opportunity cost of a large move in the underlying stock.
