A STRATEGY FOR TRADING STOCK OPTIONS THAT ROCKS
...There are thousands of strategies possible with stock options. This particular strategy helped me enjoy more than 800% annualized gains for a season prior to the market crashing. I assembled it from an array of sources, philosophies, and mechanisms. I'm making it public so others can benefit, and even improve on it. However, there's still a significant amount of study one needs to do beyond these summary points.
I also suggest you wait until the market heals before taking it for a test drive with real money. Without question, be sure that you've been adequately schooled in trading options, and that you've done virtual trading for at least six months successfully with fake money. Then, and only then, trade real money that you can afford to lose. Your results are not guaranteed, by any means. Invest at your own risk, but have fun as you explore this approach. Customize it to your needs and trading personality.
In general terms, I did the following...
(1) I use Vector Vest (www.vectorvest.com). I think their service is about $60 a month. It's brilliant. They scan about 11,000 stocks each day to discover an array of fundamental factors for each stock, and they rate all the fundamentals combined into one "VST" number. However, there are scores and scores of search filters to configure stock lists according to your approach.
(2) I then scan for the top VST stocks which have taken a brief 10 day bull pullback. I make a list of about 20-30 of these.
(3) I then look up each of the 20-30 stocks (on OptionsXpress.com) and see which ones have the best profit potential on spreads. I usually narrow it down to 1-3 of the top choices of a given week, and I go with a 5-6 month spread.
The reason I do the above three steps and get a longer term option is two-fold...
(a) I want more time to be right (as opposed to most folks who get 30-day options and lose often), and...
(b) that's because of the genius of Warren Buffett's mentor, Benjamin Graham. He's the father of value investing and he coined a crucial concept. He explained that in the short run, the market is like a voting machine--assessing which firms are popular and unpopular. But in the long run, the market is like a weighing machine—truly taking inventory of the substance of each company. So, what matters in the long run is a company's actual underlying business performance and solid fundamentals—not Wall Street’s fleeting fancy it feels for the fickle moment.
(4) Once I select the best of the best stock options in terms of Greeks, price, etc., I take my trusty financial calculator and project the most likely future price of the stock in 5-6 months based on it's past price trend. To get that, I average the stock's price trends over the last 2 years and over the past 6 months.
(5) Meanwhile, as a backdrop to this strategy, I immerse my mind in CNBC, especially Larry Kudlow and Fast Money. Those two TV shows together provide a priceless insight to the heartbeat of the economy, the market, sectors, industries, and trends. If you watch them every day, your neurons and dendrites will eventually vibrate at the same exact frequency of the market. Well, not exactly, but you'll have a keen sense of what's going on and you'll have great peripheral vision as a trader.
(6) To form a final conviction on a stock options trade, I'll study the Candlestick charts. For those of you not familiar with Candlestick stock charts, I'll give a brief summary.
More than 100 years ago, a very successful and wealthy Japanese rice trader named Munehisa Homma developed trading principles that we use today. His principles evolved into Japanese Candlesticks, an array of symbols that pack a wallop of information into a tiny space including: the market's emotion and psychology for the day--or other adjustable time span--regarding a stock, an indication of supply and demand for that stock, and a forecast of where that stock is likely going since Candlesticks are, themselves, somewhat of a "market moving" force.
Steve Nison brought this ancient technology to the Western world and, thus, to Wall Street in 1990. (He's got some great books on the subject.)
It's so cool when an ancient technology, like Homma's 100-year-old rice trading system, is so solid and smart that our high-tech world is illuminated by it, and then depends on it.
To some traders, stock charts may seem like reading tea leaves, but there are plenty of Mutual Fund managers who, after forming decisions based on the fundamentals, wouldn't make a move without a blessing from the stock charts. So, I believe that the best strategy for stock options takes into account both technicals and fundamentals.
With all of these steps completed, I place my trades.
As I mentioned, this entire approach was getting me about 800%+ annualized gain BEFORE the big market meltdown. Until the market heals, I'm very cautious. I'm just now beginning to sneak back in. Commodities are displaying some signs of life, and other market indicators are giving the appearance that a bottom has been reached. But hey! How many times has the market faked us out over the past year?
Have fun! Be safe!
--Bob