In the game of trading, many traders rush to be the first in when a stock moves up or the first out before a stock plunges lower. It’s a huge ego boost to “call that shot”. Unfortunately, it’s not a good strategy when options trading for income.
The reason is simple: These trading decisions are often impulsive. A stock that is rising may seem like a smart pick, but numerous buyers have been burned lately when they jumped in too quickly. In addition, shorting or selling a breakout may also be a premature move. You won’t know until you run technical analysis.
The key to options trading for income
This brings me to my main point. Never buy or sell on a stock’s first big move when trading options for income.
If you want to trade over the long-term, you need to have patience. Wait for confirmation of the move FIRST. Then look at the indicators for positive signals.
Afraid you might be missing out? You probably are not missing a thing. I have learned that I don’t need to be the first one in, because it may be far too early. You see, a first move down is driven by panic, and it is rarely the only selling that occurs. Expect aftershocks when reality sets in. Likewise, a huge breakout will be followed by commitment from buyers who anticipate more upside to come.
I’m perfectly okay with being late to the party. I know that if a positive new trend is taking place, I will have plenty of time to get on board. If a lower range is being established, I can pull the trade out of my portfolio with minimal damage.
This strategy has paid off for us recently. Just last week, Twitter (TWTR) posted some disappointing earnings. The stock plunged, and traders grabbed all the stock they could while it sat in the low 40’s. Unfortunately, the selloff was not finished. The stock continued lower until it finally reached the upper 30s.
In a flash, Twitter’s 46% gains YTD were wiped out. The buyers who jumped in prematurely? They’re now under water by at least 10%. Oh sure, the stock will bounce back at some point. Do you want to wait around just to break even? Of course not! We are here to make money.
If those jumpy buyers had exhibited just a little patience and waited one day, they would not be in the hole right now.
Here’s one more example for you. We had our eye on Chesapeake Energy (CHK), which had been showing some robust volume and strong option flow. Much of that activity was concentrated on Tuesday and Wednesday, yet a price breakout was not confirmed until Thursday and Friday. I waited til then to buy July 15 calls (see chart above).
By waiting for price confirmation and a turn in technicals, I felt confident that this trade would work out. So far, the trade is up 35% in just under two days.
Use options trading 101 knowledge to your benefit. Be patient and wait for the next move. This will ensure you have better odds of following a trend to profits. And that is what our goal is when options trading for income.