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Screening Key Technicals To Select Option Trade Types


Controlling portfolio beta, which measures overall systemic risk of a portfolio compared to the market on a whole is essential as these markets continue to break record high after record high with violent pullbacks. The month of September was a prime example as the markets pushed to new all-time highs early in the month then suffered a deep sell-off to only bounce back to new record highs in October. Controlling beta while generating in-line or superior returns relative to the market is the goal with an options-based portfolio. A beta-controlled portfolio can be achieved via a blended options-based approach where ~50% cash is held in conjunction with long index-based equities and an options component. Options alone cannot be the sole driver of portfolio appreciation however options can play a critical component in the overall portfolio construction to control beta when following the 10 rules of option trading.

Generating consistent monthly income while defining risk, leveraging a minimal amount of capital and maximizing return on capital is the core of an options-based/beta-controlled portfolio strategy. Options can enable smooth and consistent portfolio appreciation without guessing which way the market will move. Options enable the possibility to generate consistent monthly income in a high probability manner in various market scenarios. An options-based portfolio provides durability and resiliency to drive portfolio results with substantially less risk via a beta-controlled manner. Using basic technical indicators and key dates can aide in trade type selection such as covered calls, put spreads, call spreads or iron condors (Figures 1 and 2).

Figure 1 – Options screening tool highlighting key technical indicators and dates to aide in selecting option trade types (covered calls, put spreads, call spreads or iron condors) - Options Screening Tool.

Figure 2 – Options screening tool drilling down to ticker-specific interactive stock chart to compare historical data and a wide range of technical indicators to aide in selecting option trade types (covered calls, put spreads, call spreads or iron condors) - Options Screening Tool.

Type Trade Selections:

When selecting potential option trades, focusing in on highly liquid and well established large-cap companies is key. The options screening tool works off a database of 70 large capitalization stocks and ETFs with ample sector diversity and liquidity in the options market. One can quickly identify and filter by key technical indicators such as: Relative Strength Index (RSI), Bollinger Band Rank, Dividend Date and Earnings Date to aide in option trade selection. Th Relative Strength Index (RSI) and Bollinger Band Rank directly feed into identifying high IV stocks and IV Rank. These key technical indicators can assist options traders with directional trade strategies such as covered calls, call spreads, put spreads or neutral trade strategies such as iron condors.

Relative Strength Index (RSI)​: A momentum indicator, which calculates the magnitude of a price change to assess overbought and oversold conditions in the price of an asset. RSI indicates whether or not a stock is in oversold (value below 30) or overbought (value over 70) conditions. These values can assist traders in directional trades such as put spreads and/or call spreads. Bollinger Bands: A moving average of the underlying stock price enveloped by an upper and lower band. These bands are plotted at a 2 standard deviation level above and below the moving average of the stock price. Bollinger bands help determine whether prices are relatively high or low on a relative basis. Bollinger Bands Rank: Where the current value ranks relative to the range between the lower and upper band. A high percentage indicates the price is relatively high and a low percentage indicates that the price is relatively low. A value over 100% indicates the upper Bollinger band is broken and a negative value indicates the lower Bollinger band is broken. These values can assist traders in directional trades such as put spreads and/or call spreads. Earnings Date: A key volatility event that can have a significant influence on options premiums. These events can be used as earnings plays or avoided altogether when engaging in options trading. Dividend Date: A key event to consider when selling covered calls as the owner of the shares will want to ensure that the dividend payout will be credit prior to any potential for the shares to be relinquished.

Collectively, these key technicals and dates can serve as a framework when executing directional trade and/or neutral trades.

10 Rules for an Agile Options Strategy:

A disciplined approach to an agile options-based portfolio is essential to navigate pockets of volatility and circumvent market declines. A slew of protective measures should be deployed if options are used to drive portfolio results. When selling options and managing an options-based portfolio the following rules of option trading guidelines are essential (Figure 3):

1) Trade across a wide array of uncorrelated tickers

2) Maximize sector diversity

3) Spread option contracts over various expiration dates

4) Sell options in high implied volatility environments

5) Manage winning trades

6) Use defined-risk trades

7) Maintains a ~50% cash level

8) Maximize the number of trades so the probabilities play out to the expected outcomes

9) Place probability of success in your favor (delta)

10) Appropriate position sizing/trade allocation

Figure 3 – 10 foundational rules to follow when engaging in options trading - Tr