How to Use Technical Indicators to Maximize Your Option Selling Results
OPTION SELLING INSTITUTE
Fundamentals may take priority for commodity option sellers. But knowing how to properly employ a few technical indicators can give you a powerful extra edge.
In 1992, I went to my very first trading seminar in Orlando, Florida. I do not remember the name of the seminar or the presenter. The premise, of course, was that I was going to learn how to get rich trading stocks and commodities.
The middle aged man giving the seminar, which I had paid $199 to hear, was as gung ho on his methods as was I to learn them. We learned a few things about top and bottom formations, moving averages, et.. But the real teaching was about this gentleman’s “custom” signals he had developed and was willing to sell to us on a monthly basis for an ongoing fee (How generous of him.)
During demonstration of these indicators, he happened to throw a chart up on the wall showing a “false” signal.
Being a naïve beginner, I raised my hand.
“What is a ‘false’ signal?” I inquired.
“It’s when the signal doesn’t work.” He coolly responded.
“Why wouldn’t it work?” I asked, again exhibiting my status as neophyte.
He looked at my quizzically. “The signals don’t always work,” he quipped as though explaining to a child that the world isn’t flat.
“Then what good is it?” I thought to myself.
My experience with technical analysis has been a mixed bag ever since that fateful day. But through years of study, analysis and plain old trial and error, we’ve discovered that, despite the drawbacks, using technicals the right way can give you and edge as an option seller. The problem is, the right way isn’t typically the way most individual investors approach it.
The Knock on Technical Indicators
The big knock on technicals, of course, is that they work…..until they don’t. I think of them kind of how you think of that old Chevy you owned when you were 19. You may have used it to get you around town. But you wouldn’t trust it on a long trip. Because just when you need it most, in the rainstorm, 100 miles from home, at 2 am, is when it fails you.
I find it hard to place the safety of my capital into a method whose argument is that it can give me better odds than a coin flip (maybe).
Technicals Can be Useful to You
We have been criticized in the past (by technicians of course) for dismissing technical indicators in favor of the fundamentals. So be it. I’d rather make money than debate anyway. But we never dismissed technical indicators.
We merely gave them a lower priority when selling options on commodities.
- Because technical buy/sell signals are often wrong
- Because, in our opinion, they tend to be a measure of momentum and thus, are more useful on projecting short term moves. As an option seller, you are less concerned with short term swings and more concerned with long term direction (or non-direction.) For this, you must almost certainly turn to fundamentals.
In our combined 50 years of trading futures options, we’ve soundly concluded that, at least in the commodities markets, the fundamentals should be the priority. This is because it is our belief that over the short term, markets DO MOVE RANDOMLY. It is only when taking a longer term perspective do fundamentals begin to bring a kind of order and reason to the market. That makes them MOST VALUABLE to option sellers.
…you wait for technical indicators to give signals that match your fundamentals bias.
This does not mean that you shouldn’t incorporate some technical analysis into your option selling . Quite the contrary, including some technical analysis into the timing of your trades can help give your options a “head start” which ultimately increases your odds of success.
This is not a seminar on the best technical indicators but rather, how you employ your favorite ones into option selling.
Below you’ll find the most effective way two old school fundamental traders (ie: the authors) have found to employ technical analysis into timing your option sales. We’ve termed this the Congruence System for using technical indicators for commodities options.
How to Employ Technical Indicators in Your Option Selling:
- Choose 1-3 technical indicators with which you are comfortable (more simply muddies the waters)
- Look for confirmation between your indicators
- Take only the “buy” or “sell” signals that are congruent with your fundamental view of the underlying market. (Most Important)
Remember, you should be selling options based on the long term fundamental bias of the market. You are incorporating technicals only for timing purposes.
In other words, you are using fundamentals to select the markets you want to be in. You are using technicals to help tell you when to sells the options (or buy them back – but that is another seminar.)
EXAMPLE: Selling Calls in Corn Futures
For instance, suppose you are fundamentally bearish the Corn market and want to sell calls. Your Slow Stochastic and RSI are both indicating a buy. Do you still sell your calls?
Bullish technicals but bearish fundamentals. Do you sell calls now or wait for technicals to match your fundamental bias?
Likely not. You do not act at all. You simply wait until your indicators are indicating a moderate to strong SELL. Then you sell your calls. In other words, you wait for technical indicators to give signals that match your fundamentals bias.
Selling Options this way gives you Three Advantages:
As an option seller, you may find the system below most useful in employing technical analysis:
- If the market is technically overbought and indicating sell, the price of the commodity has likely risen and the calls* will be commanding higher premiums. This can potentially mean more money in your account.
- You give yourself the potential edge of having momentum working in your favor to start the trade. Starting a short option sale in the black can make for a smoother, low maintenance path to expiration for you.
- Even if your technical signal turns out to be a “false” signal, you still have the fundamentals in your favor. As an option seller, that’s often enough. Thus, even if you’re technical indicator is off, you can still have a winning trade.
* The same technique can be used when selling puts
Waiting for a Perfect Set Up?
Perfect technical set ups rarely come around. If you wait for them, you’ll never get enough premium in your account. Remember, your timing doesn’t need to be exact when selling options. Close is good enough. But getting technical momentum right can start your option out on a track of immediate decay.
Once an option starts to decay, it has a hard time coming back. That is how you want to begin every option sale.
Using a few technical indicators to time your entry is simply another way to potentially move a few more pounds to your side of the see-saw – to tip the odds just a little bit more in your favor. In this role, it can be useful to you. Just remember, selling options is like a baseball game in that, it doesn’t matter if you win by 15 runs or win 1-0. A win is a win. You get the same premium regardless.
Anything that tilts the odds a little more in your favor is worth the effort. Despite its drawbacks, properly blending technical analysis into your option sales can give you an edge. Using the system described above can help you do just that.
Michael Gross is Director of Market Research at OptionSellers.com in Tampa, Florida. He is co¬author of the book The Complete Guide to Option Selling 1st, 2nd and 3rd Editions (McGraw-Hill 2015).
With over 18 years of experience in futures and options, Michael is a regularly featured guest author in a variety of financial publications. Michael’s published works on option selling in the commodities markets have appeared on Yahoo Finance, Forbes.com, Businessweek.com, Optionetics.com and Futures Magazine. His market comments have been featured by Barron’s, The Wall Street Journal, Reuters World News, Dow Jones Newswires, Kitco, and Fox Business News.