A Strategy For Day Trading Options On High-End Stocks

Looking for a new option trading strategy? Here’s one I read about on SeekingAlpha.com that looks interesting and possibly quite lucrative. It involves buying options on relatively expensive stocks (over $100 per share), that have large daily price swings.

A little over a month ago, I wrote an article posted on Seeking Alpha about how I trade CF Industries (CF) on a daily basis using stock options. Please read that article as it will give you a nice head-start on what I will be going into for this article.

To expand on my previous article, I am of the opinion that it is easier to spot a bottom with a stock daily than it is to spot the top. While put options work great with this strategy, I would say my overall ratio of placing calls to puts is 5:1. This strategy takes advantage of the large daily price swings, while also recognizing the bottom or top in a stock price in the short-term. It is also cognizant of market conditions and current volatility.

Since the article was released, I have received more e-mails and questions on this article than any other. While I briefly mentioned other stocks this strategy works well with, I did not go into any great detail on any of them. This article should clear up a few of those questions.

This is a good opportunity to elaborate more on this strategy and mention the other stocks you can use this strategy with. I also provide an image of how the streaming chart with all five indicators should appear.

I am always looking for “new” potential stocks to place this trade with. Although time consuming, I do many trial runs on a particular stock to see if they work. In the future, I will add to my list and make them known on my InstaBlog. You may even know of certain stocks that I haven’t tried with this strategy that may work. If so, let me know via the comment section or e-mail, and I will definitely check it out.

I have been trading this strategy for years. Over time, some of the stocks have changed. A great example is Potash, Inc. (POT). This was formerly a great stock to use this strategy on. When it did a stock split, it took out all of the “juice” that it had. It simply doesn’t move enough anymore. In other words, Potash got kicked out.

For the most part, the criteria that a stock needs to qualify it as a trade possibility follows:

  • The stock should at least be $100/share or more (There are exceptions, which I will mention later in the article).
  • The options for the underlying stock must have liquidity.
  • The underlying stock has large price swings daily (i.e. volatile daily)

The stocks that I currently use with this strategy with are the following:

  • CF Industries (CF) – strategy works great with this stock.
  • Apple, Inc. (AAPL) – is right up there with (CF) as a favorite.
  • Google (GOOG) – Google works extremely well, too.
  • Baidu (BIDU) – while I don’t trade (BIDU) as frequently, I have always had success when I do.
  • Wynn Resorts (WYNN) – another stock that works very well.
  • Netflix (NFLX) – haven’t used it much since it fell below $100/share. A bit too risky now.
  • Sina Corp. (SINA) – even though it’s under $100/share right now, this is one of the easier stocks to spot a bottom with on a daily chart. Very volatile, which is perfect for this strategy.
  • Chipotle Mexican Grill (CMG) – is lacking in liquidity at times, causing the bid/ask spread to be wide, so be careful. Easy to spot a bottom, however.
  • Intuitive Surgical (ISRG) – similar to (CMG) in that liquidity can be a issue, but this stock is a serious mover that consistently makes money for me.

Often, too many traders rely on only one indicator to tell them when to buy or sell a stock or option, such as the Relative Strength Index or the SMA/EMA. While I like these indicators and use them, this is simply not enough information to go on. Having only one or two indicators can easily send a false buy or sell signal. My strategy uses five indicators, all independent of one another. I will never place a trade until all five of my signals are reached at my set criteria and at the same time.

When two or three indicators signal a buy signal, this is a good confirmation. However, when all five hit the mark, this is very significant. It doesn’t happen as many times daily on a given stock.

It takes a lot of discipline to not make the trade until all five indicators reach their buy point. On some days, you may get four buy signals a day on a single stock. Other days, there is only one. CF on Monday had one buy signal all day, at 11:28 a.m.

Also important to this strategy is that I will not make any trades until one hour has passed since the markets have opened. You really need to let your streaming chart form and to see a trend. This will also avoid false signals that large, early price moves can bring. I also try to avoid trading in the last hour of the markets being open. This is more of a personal choice because I do not like to hold a position overnight if I don’t have to. The only exception is Apple (AAPL), which sees a lot of movement in the last hour of trading.

Current market conditions also play a role. For instance, if Ben Bernanke is scheduled to speak at 11:00 a.m, I will wait to make a trade until I see how the markets have reacted to it. Also, always be sure to be on top of any news that is related to the stock you may be trading that day. An example would be if a report came out earlier in the day mentioning something that might be detrimental to a stock in the short term. You don’t want to be holding call options only to find out there is little chance the stock is going to move up during the day. Basic stuff, really.

See Seeking Alpha for the remainder of the article

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