Hold Your Horses, Option Traders

Patience. It is a key attribute to a successful trader in my humble opinion. As I like to say, when the market is open and those candlesticks (if you use candlesticks) are moving, the blood is pumping and emotions are running high. But a trader needs to be calm and not let these moves takes away from his or her objective. Let’s take a look at what I mean in regard to selling premium generally as an investor.

Short Options

Selling a call option against a stock position is commonly done by investors (covered call). The call option’s strike is generally sold where the investor thinks the stock will be at the short call’s expiration. The call option expires worthless and maximum is earned for the stock position without being called away (assigned). When a time spread is bought (calendar or diagonal), the maximum profit is earned if the stock closes right at the short strike at the short expiration (just like a covered call) for either a call or put. Choosing which strike to sell is sometimes a challenge, but potential support and resistance can help.

Support and Resistance

Selling the short option close to a support or resistance area makes sense. The reason is that support and resistance have a better chance to hold than be broken. But using a covered call as an example, when the stock price moves through a resistance area and is trading above the short call’s strike, the first thing many option traders want to do is buy back the short option and roll to a higher strike. This works when the stock does indeed continue to move higher. But knowing support and resistance have a better chance to hold, it may make sense to show a little patience. Let’s take a look at a recent example below.

This 60-minute chart of Apple Inc. (AAPL) shows the end of May to the beginning of June 2020. The stock had some potential resistance around the $322 to $323 area as designated by the horizontal line. The area was tested numerous times. Going back to what you know as a trader, resistance has a better chance to keep the stock from moving higher. In fact, it was turned away several times.

In my Group Coaching class and one-on-one coaching sessions, I had several option traders asking what they should roll either their covered calls or time spreads up to. I replied with let’s see if the stock can break that resistance before buying back the short position and selling a higher strike. I ask them, what has a better chance of happening? If they are a student of mine, they know resistance like support will hold more times than not. Of course, that will not always be the case, but it will be the majority of the time. The odds are on your side!

Lastly…

Obviously, there are times to close out the short position and sell another strike higher or lower depending on the expected move. The key is to let the stock or whatever you are trading prove to you that it does want to break resistance or support. Closing above it or below it just once does not mean it is going to break that level. You want to see generally two consecutive closes through the potential support or resistance. The 2-bar close principle (2 consecutive closes above resistance or below support) has served me well as a technical trader. Remember to ask yourself on any trade, what has a better chance of happening?

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.