Date: 8/3/2021
Author: Chris Hood
Be sure to check out new episodes of my video podcast each week, where my ace pupil Brian Jones and I talk the ins and outs of options trading- and give you insights and strategy that you can immediately put to work for you in the markets.
In markets with low implied volatility, focusing on directional options buying strategies makes the most sense.
Why is this the case?
When IV is low (under 50%), options aren’t that expensive. This means that as a buyer, you get them at a discount, and expansions of volatility can help drive up the price.
Selling in low IV environments doesn’t pay you enough for the risk you take.
Lower premium, higher risk, and the possibility of a volatility spike offsetting the time erosion you hope for make options selling a less-than-optimal strategy.
Let’s take a look at two of my favorite bullish directional strategies – the long call and the bull call debit spread.
First, we need to establish some entry criteria for these trades.
If you’re consistently making money in the market, you’ll have these written down, and you’ll have set your buy and sell alerts in your trading platform.
Whatever your rules are, then stick to them. If you don’t, you aren’t going to succeed.
Let’s assume that your set of technical indicators identifies a long-term uptrend in a stock or index, and one of your primary buy zones is the 34 EMA.
For the record, I use this level often as a buying zone.
In particular, strong stocks and indexes tend to bounce off the 34 EMA and continue their trend. A couple of daily closes below this level, and I consider the trend broken.
Time to exit.
Next, when should you use a long call versus a bull call spread?
I use the same criteria to enter both types of trade. They operate on the same bullish assumptions, gaining value when the stock price rises.
The critical difference is in the cost of the trade.
Take, for example, a high-priced stock like GOOGL. If you buy the Nov 19, 2021, 2500 strike call option, it’s going to cost you $26,010.00.
Keeping this position to about 1% of your trading capital means you’d need about 2.6 million in your account.
For some, that’s not a problem, but for most, it simply isn’t affordable.
So rather than playing a long call, you could buy a bull call debit spread (GOOGL 19 Nov 21 2660/2700 Call) for only $2,075.
It’s a much more reasonable allocation.
The call spread caps your maximum gain on the trade, but it is a way to play the movement in the stock with less expense.
On lower-priced stocks, particularly with less time to expiration, you could get into a trade for less than $200.00.
So often, the bull call debit spread is a method of trading stocks you couldn’t otherwise afford.
Finally, let’s consider trade duration.
When playing long trends, you must avoid excessive time decay to be profitable. Call options lose value each day, and the closer to expiration, the faster it happens.
This means that you have time to be correct, and your long calls or debit spreads can handle some dips in price.
In fact, when trend trading, these dips allow you to add to your existing trade.
Purchasing additional calls and call debit spreads on pullbacks is an excellent way to build a more significant profitable position.
The key is planning.
Using your watchlist, find uptrending stocks and develop a focus list. Then, use long-dated calls and spreads to play the major trend while using short-duration options for quick upswings.
None of this is possible without setting your buy and sell levels.
Essentially, no one becomes a good trader by being lazy and ignoring the charts. Forget the television talking heads and chat group gurus.
Develop a system that works for you.
I’m here to help you do just that.
