Do You Ever Pivot From Long Put Options To Long Call Options?
Posted by Pete Stolcers on July 4, 2008
Option Trading Question
Do you ever consider moving a stock from a bullish watchlist to a bearish watchlist without waiting for your scan to do it for you?
Option Trading Answer
First of all, my scans run independent of my personal bias and my input is limited to my original algorithms. In other words, I do not have any manual criteria that I enter. I simply interpret the results using pattern recognition. There are times when a stock is very volatile and it will flip from a bullish search to a bearish search in a short period of time. In general, those situations are unpredictable and should be avoided.
The greater question deals with changing your directional opinion on a stock. This is a very dangerous practice and it is a pitfall for most novice traders. For some reason, they zero-in on a particular stock (i.e. Google) and they decide that that is all they’re going to trade. One minute they love it, the next they hate it. I equate this to a fish flopping from side to side on the shoreline. Eventually it takes its last breath.
In the process of becoming a better trader, yes I have second and third guessed myself. I would get into a trade and it would immediately head against me. After watching the price action I would wonder how I could have been so stupid. It was obvious the stock was heading the other way. As soon as I would pivot into the opposing position I would watch the stock reverse again and head in the direction I originally expected. I’ve made it a rule to never make a trade unless I had a strong directional opinion. If I was wrong, I need to take my lumps and move on. If you subject yourself to this mental anguish, it will ruin your confidence and you will be forever second-guessing yourself.
There are times when I stop out of a trade with the intent of getting back in on the same side. For instance, if a stock is in a downtrend and I’m short, I will identify a minor resistance level and place a stop there. If the stock has a short covering bounce from an oversold condition, I limit my loss and I stop out. I’ll watch the stock with the intent of re-entering the trade at a better level once the rally has exhausted itself. My original opinion needs to be firmly intact and the rally can’t be the result of a material change in the company.
Now I’ll give you an example of a very rare circumstance. At times I sell out-of-the-money call credit spreads on a high flying overvalued stocks that have “topped out”. If a well-defined resistance level has formed, I will sell a call that is above the resistance level and buy an even farther out call to limit my risk. If the stock does the unexpected and it makes a new high, I will buy-in the short call and hold the long call. Usually the impetus of the breakout will continue for a few days and I can mitigate some of my losses by legging out. The same would be true for a stock where I’ve sold an out-of-the-money put spread below a key support level. If the stock breaks-down, I may buy in the short and hold the long for a day or two on a very short leash. I don’t want to compound the damage from bad trade.
In short, form an opinion and stick with it. If it’s wrong, take your losses and move on.