OPTIONS
The Provest Option Trading Method
A Structured Approach To Option Trading
by Jay Kaeppel
This is the first in a series of articles about option trading
with the Provest option trading method. The Provest method is not a trading
system. Rather, it utilizes a series of criteria that can aid option traders
in choosing the proper trading strategy for a given situation. Likewise,
traders are free to choose different parameters to apply to each of the
key criteria. This month’s article lays the groundwork for the strategy
pieces to follow in the months ahead.
Option trading volume has proliferated in
recent years. Part of this is due to the advent of electronic trading,
which has greatly facilitated the flow of information and trading activity.
In many cases, traders can get into and out of trades almost instantaneously.
This spectacular growth in trading volume has also been fueled by the fact
that so many individuals have become more knowledgeable about the varied
uses of options that allow them to achieve specific speculative and hedging
objectives.
Yet even as the business of option trading evolves, in the end the act
of trading options remains an art form. Unlike trading a stock or futures
contract directly — where you either go long and make money if that security
goes up or lose money if it goes down, or vice versa if you are holding
a short position — with options there can be many shades of gray. This
creates opportunities and risks unique to option traders.
Using options makes it possible to craft a trade that:
-
Makes money if a stock goes up or down (but loses money if it stays within
a range)
-
Makes money if a stock stays with a certain range (but loses money if it
breaks outside that range)
-
Makes money if a stock stays above a given price (but loses money if it
drops below that price)
-
Makes a limited amount of money if a stock goes up but loses less if the
stock goes down
-
So on and so forth.
In Figure 1 you see price action for Amgen (AMGN). If you take a moment
to analyze this chart, you can see how one trader could view this as a
stock in a downtrend, another as a stock that has been basing for a while
and ready to pop to the upside, and another still as a stock that is going
nowhere. Using options, each of these traders could enter a limited risk
position that would allow them to profit if their expected scenario came
to pass.
This array of possibilities offers both opportunity and risk. With so
many possibilities it should be fairly obvious that there can be no “one
size fits all” approach to option trading. Regardless of strategy, however,
certain criteria are universal in terms of having a potential impact on
a given option trade.
So with that in mind, the goal of this series of articles is to provide
a framework that allows traders to adopt an approach to option trading
that is as objective as possible, providing information on the key criteria
that need to be considered and how that criteria may affect a given trading
strategy.
...Continued in the January issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the January 2008
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
Return to January 2008 Contents
