Video Lesson – How To Really Use Technicals In Option Selling
Michael Gross explains How To Really Use Technicals In Option Selling.
Hi, this is Michael Gross, co-author of McGraw-Hill’s The Complete Guide to Option Selling and Director of Research here at OptionSellers.com. I’m here with your bi-monthly option seller video lesson. The topic of this week’s lesson is Using Technical Analysis in Option Selling. Now, this is not going to be a seminar on technical analysis, there are plenty of books and courses available for you to learn technical analysis and we could probably do that for 10 years, but today’s course is just going to be a quick primer for you on how to apply your favorite technical indicator to selling options. Before we jump into it, I did want to mention, if you are interested in using these type of lessons in your option selling account, we do recommend our latest book, The Complete Guide to Option Selling: Third Edition. It’s by McGraw-Hill. It is available on our website… www.OptionSellers.com/Book.
Technical analysis is a broad subject. There is a constant battle of wills or battle of philosophies in the market between fundamentally based traders and technical based traders. Both think their way is more effective. When you’re selling option premium, one of the big points we make when applying it to commodities is your focus has to be on the longer term fundamentals. People always call and ask, “Do you ever use technicals? Do you believe in technicals at all?” The answer is absolutely, you can’t discard technicals, but a key concept to remember when you’re selling commodity options is you pick your trade based on what the fundamentals of the underlying market are and then you use technical analysis in your timing. I’m going to show you what I mean by that right now.
Let’s do an example. Now, the mistake that many new commodity traders make when they’re coming into the market, “I want to diversify into commodities” or “I saw on the news that soybeans are going to go up. I want to get in on that”, which is not a good way to trade, by the way, regardless. Here’s your price chart. Here’s your technical indicator down here. Let’s just assume you’re using a simple stochastic, okay? It goes up, then it goes down, then it goes up, then it goes down. People are looking at these to get their buy and sell signals from it, and maybe you are, too. The reason so many traders that are new to commodities that have never started them and they jump in and try and trade them on their own, the reason so many people have trouble with that and a lot of new traders that try commodities end up losing money is they’re trying to trade them over the short-term. They’re trying to trade them like they trade their stocks. Because of the leverage in commodities, that’s very difficult to do. It’s difficult to do anyways, but the leverage makes it even more difficult. Short-term commodity traders are saying, ‘Well, I’m going to try and buy it here and I’m going to try and sell it here. Whatever technical indicator I’m using will hopefully help me do that.” Well, guess what? That’s one of the toughest things in the world you can do because what happens? You get to this point and your stochastic is up, right here you get a sell signal, “I’m going to go short the market. This is it. This is going to be the big move, the thing’s going to collapse, I’m going to make a ton of money, right?”
So he sells it here, it starts to go down, and then what? Boom. It takes off, he gets stopped out, he loses. “Commodity trading is no good, these things don’t work.” People try and do this over and over and over. The problem is they’re trying to time these short-term swings in the market and it’s all they’re looking at. If he would look at the bigger picture, he would be looking at supply and demand and what is actually driving the price to go lower or higher over the long-term. Selling options is more of a longer-term strategy and by longer term I mean 3-6 months, something like that. It’s not a daily thing where you’re trying to sell an option today and take your profit tomorrow, like the futures traders are trying to do. For longer-term we want to focus on the core fundamentals and what’s driving price over the longer-term. We’ve covered this in past lessons so you know that. The only thing you’re using your technicals for is in your timing. Let’s do the proper example so you can see what I mean. Back to the example, same trader. Instead of trying to time all these moves based on the technical indicators, the option seller is going to do his homework first. He’s going to get a fundamental bias, he’s going to see that the soybean crop, and we’re just making this up for example purposes, but he looks and sees the soybean crop has had some crop trouble this year, crop numbers are expected to come in a lot lower than last year and it could create a bullish type of setup for later in the year. That doesn’t tell you what price is going to do in the meantime, so what does he do? He comes down to somewhere like here, sells a put, or he wants to sell a put… I should put it that way.
Now, he’s selling a put based on his fundamental bias in the market, which is bullish. He wants to sell the put underneath the market. How does the technical indicator come into play? Well, it comes up here and he says he should short the market, but he doesn’t want to short the market so when he’s using his technical indicator he’s only going to take the bullish signals. Because it says, “I should short the market here”, he doesn’t want to short the market… he’s bullish. He doesn’t want to sell a call just because the technical indicator says it’s overbought. He’s fundamentally bullish so he’s not taking any sell signals. He’s only going to take the buy signal. He’s only going to take the bullish signal. So, it gets down here and it says buy. Instead of buying the contract because it could get stopped out, he’s using his bullish fundamental bias, it’s lining up with his technical buy signal, he has got that, and now he pulls the trigger on his put sale. That’s going to give him a high-odds start to his trade. Now, it doesn’t mean the signal is going to work, but it’s just one more thing to put in his corner. If you can get a little edge on your initial option sale where the thing even goes up for a week, it can take enough premium off it to make the rest of your time in that trade fairly comfortable, even if the market comes down a little bit more, because, as we know, once an option starts losing it’s value it’s awfully tough for it to come back, especially when you get inside that 90 day mark. That’s one thing you want to keep in mind.
What I want you to take away from this lesson is although we talk a lot about fundamental analysis in the commodities markets, which is the most important thing when you’re trading commodities, we don’t discard technical trading. We’re simply using it for our timing. If you’re going to be an option seller you can probably benefit by doing the same thing. You used your technicals to help you in your timing and whatever technical indicators you like to use, any of them can work for you. They’re just a tool in helping you to better position in your short option trade.
I hope you found this week’s lesson helpful. If you’d like to learn more about working with us directly in our private client group where we are doing both of these things for you, we’re doing all this analysis before we put on a trade in your account, I do recommend you request our Option Seller Discovery Kit. If you’re a high net-worth investor it will tell you a lot more about our private client group and how you can get involved. I hope you enjoyed the lesson this week and we’ll see you in two weeks. Thank you.