Optionable ETF & stock option

TRADING STOCK OPTION - SINGLE DIRECTION METHOD

Picking
Some members been asking, "how to choose and pick stocks to buy their options?"
First, we need to check the chart and qualify a few basic criteria:-
1. Which direction is the trend? That will determine whether we buy Call option or buy Put option.
2. Is there adequate average daily trading volume? That will relate to good Open Interest for the strike we like to trade (say maybe about 2 million shares a day over a 2 to 3 months average).
3. What is the entry signal? Here, we can use some basic indicators and time our entry. There are quite a few good systems and methods that a beginner like us can adopt.

• use a 11 day moving average together with RSI of 11 day. For uptrend, a break above the 11 DMA line with a lower RSI heading towards the centre line is a good way.
• if the trend is clear (i.e both the stock and the sector is in the same direction) use a breakout above last 2 previous high as a signal to enter.
• candlestick reversal pattern is another method - like a hammer and morning star pattern for reversal to uptrend together with a direction indicator (like GMMA)

So whatever system adopted, stick to the same method for consistency otherwise one can get confused.

Option criteria

1. The expiration - which is the best? There is no straight answer as the stock movement is unsure so we choose at least over 60 days. That is base on the style we trade the options as we follow the trend and trade single direction.

2. Which strike to choose?

Before this, most beginners will be confused over the numerous strategies like straddle, strangle, butterfly, condor, etc. For beginners, I will stick to simple single direction BUY. No SELL for beginners. Once you can determine the trend and decide to buy Call or Put, choose the cheapest strike.

Option premium = Intrinsic value + time/volatility value

So if it is slightly OTM, the premium should be cheaper. Of course the best is to choose a stock that has strike levels spread by the dollar or lesser.

3. Is the ASK - BID spread of any concern? Yes of course! The smaller the better - which means tight competition between the buyers and sellers.

4. How about the Greeks? My concern here is to compare how much the mother stock move against how much the option move. Say if mother stock move up US$2.00, the Call strikes will move up 2 levels so the premium delta will increase from a lower to a higher amount much quicker and we will get better returns. That  is the better choice. 

Example of STX expiry Oct'2012 last traded about $29.40 captured on Sept 19, 2012

STX  @ $29.40
STRIKE	PREMIUM	OPEN INT	DELTA
28	2.48	195	0.66
29	1.90	653	0.56
30	1.36	2,535	0.47
31	0.99	1,873	0.37
32	0.65	1,906	0.27

So if mother stock trading @ $29.40, we may choose to buy Call strike 30. (yellow shaded ITM).

So you noticed that the strikes are a dollar apart and if it moves to 31.40, theoretically the option delta would then be about 0.66 (from current position of 0.47) That means we get higher intrinsic value.

5. What about the O/I? Open Interest should be high enough to trade for stocks with good average trading volumes. For this example, it is considered high O/I so very liquid.

Watch list

But how to scan the market with so many thousands of stocks?

Why not try the ETF? Here are some good ones we can watch out:-

INDEX ETF
DIA	SPDR Dow Jones Industrial Average
QQQ	PowerShares QQQ Trust Series 1
IWM	iShares Russell 2000 Index
SPY	SPDR S&P 500
SECTOR ETF
IYR	iShares Dow Jones U.S. Real Estate Index
XRT	SPDR S&P Retail
XLY	Select Sector SPDR Consumer Discretionary
XLE	Select Sector SPDR Energy
XLF	Select Sector SPDR Financial
XLV	Select Sector SPDR Health Care
XLI	Select Sector SPDR Industrial
XLB	Select Sector SPDR Materials
XLK	Select Sector SPDR Technology
XLU	Select Sector SPDR Utilities
COMMODITIES ETF
USO	US Oil Fund
IAU	iShares Gold
GLD	SPDR Gold
SLV	iShares Silver
GDX	Market Vectors Trust Market Vectors Gold Miners

Happy Trading folks!

Quotes of Jesse Livermore:-

(from his book “How to trade in stocks’)

All through time people have basically acted and reacted the same way in the market as a result of greed, fear, ignorance and hope. That is why the numerical formations and chart patterns recur on a constant basis.

If you cannot make money out of the leading active stocks, you are not going to make money out of other stocks. (FOLLOW THE LEADERS)