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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.

Option Trading Comments

  • On 07/19, Harvey Warren said:

    A simple strategy never discussed: buy equal number of long calls and long puts on same underlying equity - same month and strike price.  Enter fairly tight stop loss orders on both positions.  Place order shortly before major announcement (earnings report).
    One or the other will be stopped out and the other will run.

  • On 07/19, Pete Stolcers said:

    Hi Harvey,

    That strategy is called a strangle if out of the money options are used and a straddle if at the money options are used. I did writean article on it about a year ago and gave a pre-announcement example.

    To find the article, just enter the word straddle into the search box.

    The strategy can work, but on a limited basis. The problem with it is the implied volatilities on both options are inflated ahead of the number. If the stock fails to make a move of more than 5% you will lose money. There in lies the key. You have to find companies that have a chance to surprise big either way.

    I prefer to find stocks that have raised, lowered guidance and have not moved materially since the news. Then I take the direction of the guidance and I wait for the number. When possible, I use front month options. This expiration I have already hit SCHN and GE.

    If you have a strong trending market, look for opportunities that match the direction of the trend (bullish or bearish). Also look for the groups that are leading that move and use the strongest/weakest stock.

    Thnx for the comment.

  • On 04/01, Harvey Warren said:

    The Strangle/straddle use the same month, but I have also found it effective in an uncertain market to buy a leap call, confident in longer term outcome, but at the same time a near month put one or two strikes OTM for protection when initiating the position, and perhaps again for a longer term if profits arrive early on the long call.  Of course, rolling out this strategy very often will eventually eradicate profits so it must be used only on occasions, as needed.  Stop losses on these long puts can be entered at key resistance points triggered by a chosen stock price so that the order does not hang around on the books for all to see. Protective puts are often deployed only with stock positions but there is no reason not to use them with long calls.

  • On 04/02, Pete Stolcers said:

    Your strategy will certainly work, however, there might be a better approach to consider. It sounds like you are a long term bull and you like to buy LEAPS. If you are picking stocks with relative strength, they should hold up better than the overall market. When the market breaks key support (100-day MA, major trendline, intermediate horizontal support), short the SPY or buy puts on it. It is very liquid (low slippage) and when the storm passes, you only have one trade to exit/monitor. You can calculate the number of puts to buy (SPY shares to short) based on your position. I wrote and article about this approach. Use the search feature and query “hedging”.

    This will only protect you from market risk. You still have the risk associated with the stock. Before you take a LEAP position, you have to make sure the long term fundamentals are intact - no surprises.

  • On 05/15, shruti mehrotra said:

    how do u trade in pivot or cross currency options like usd/jpy then i want to understand the stratagies like u take a put of one and call on other but if at the end i want usd in my hand how do i apply it?

  • On 05/15, Pete Stolcers said:

    I don’t trade currencies and other traders are more qualified to answer your question.

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