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:
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.
- 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.
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.
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