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This Is My Option Trading Game Plan For the First Month - Watch For These Patterns Today

Posted by Pete Stolcers on January 2

Posted 9:30 AM ET – The 20’s are going to start on a positive note and the S&P 500 is up 18 points before the open. It will challenge the all-time high that was set last Friday. I will be watching for signs of early selling and the bid will be tested. The price action this morning will help me gauge resistance. If we back off quickly and drift lower the entire day could be vulnerable to profit-taking is heavy. If the market is able to hold the early gains and grind higher we might have a little more headroom.

I am very skeptical of the last leg of this rally. Good news is priced in and stocks are trading at a fairly rich forward P/E of 18. Stocks need time to grow into their current valuations. I believe we will see profit-taking during the first quarter of the year and we will establish the low-end of a trading range. The second quarter will be spent on both extremes of that trading range and stocks will move sideways.

China reduced bank reserve requirements by 50 basis points and that is boosting Asian markets.

The news cycle will be fairly light the rest of the week. Chinese officials could sign the Phase 1 deal in the next week and that is expected. Boris Johnson will take big strides in the next few weeks to make sure that Brexit happens by the January 31st deadline. It’s good that this dark cloud has parted, but taking the fifth largest economy in the world out of the EU will impact the Eurodollar. I will be watching credit markets. Germany is the largest EU member and they are on the brink of a recession.

The new head of the ECB is Christine Legarde. She has criticized EU governments that have tried to balance budgets and she is calling for massive fiscal stimulus. This type of rhetoric scares me since many EU members have been running huge budget deficits (PIIGS). This is a longer-term credit concern.

For now, domestic economic growth is strong and corporate guidance has been positive. Earnings season starts in two weeks and we will be able to gauge profit-taking.

Swing traders should be long VXX – Set a target of 18 and hold without a stop. This position will hedge any remaining bullish put spreads you have on. I am 90% in cash and I will patiently wait for a market dip. The market is technically over-extended and I don’t believe Asset Managers will chase at these valuations. The first market pullback this year should be brief and I believe SPY $316 will be tested. That will set up an opportunity to sell very short-term bullish put spreads. The market bounce from that dip should last halfway through earnings season. There are a few scenarios that can play out after that and I will update you along the way. Rather than outline all of them, I will just watch the price action and I will provide instructions.

Day traders should watch for early selling. If the market immediately retraces with two long red bars closing near their low on a five-minute basis it will mean that stocks will drift lower the first half of the day. If the market moves higher during the first 30 minutes and then takes out the low of the day an excellent shorting opportunity will present itself. I will be focusing on the short side for my day trades. If the market gradually grinds higher all day I will be fairly passive with my trading.

I’m starting the year with a neutral to slightly bearish bias. This does not mean that I am loading up on put positions. The macro backdrop remains strong and it is foolish to pick tops and to fade strong rallies. I am simply being prudent. I locked-in fantastic profits from the last four months. If other traders feel the same way that I do, we will get the dip I’m looking for and we will be able to reload at much better levels. I will not be carrying overnight shorts.
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