Every day I’m looking at stock charts for specific situations in which to sell options to generate income for my accounts. Options to me are a short term trading strategy so there’s really no reason to do much fundamental analysis of the underlying company. This is really a chart based trading strategy and I like to enter and exit these things within the limits of a work week, if possible. I like weekends off just like everyone else.
My two favorite stock price indicators for trading options are Bollinger Bands and the MACD. Bollinger Bands I’ll leave for another discussion. Right now I’d like to lay out my strategy for using the MACD. As I pointed out in an earlier post, crossing the signal line is most effective when the MACD is below the zero line and crosses the signal line from below or above the zero line and crosses the signal line from above. I also pointed out that correctly crossing the signal line is the initial trading signal and subsequently crossing the zero line is confirmation of that decision. Finally, I warned that an MACD crossing a signal line from below when it is above the zero line and crossing from above when it is below the zero line is generally a false signal and shouldn’t be used as a reliable trading signal.
My two favorite stock price indicators for trading options are Bollinger Bands and the MACD. Bollinger Bands I’ll leave for another discussion. Right now I’d like to lay out my strategy for using the MACD. As I pointed out in an earlier post, crossing the signal line is most effective when the MACD is below the zero line and crosses the signal line from below or above the zero line and crosses the signal line from above. I also pointed out that correctly crossing the signal line is the initial trading signal and subsequently crossing the zero line is confirmation of that decision. Finally, I warned that an MACD crossing a signal line from below when it is above the zero line and crossing from above when it is below the zero line is generally a false signal and shouldn’t be used as a reliable trading signal.
"We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful." |
As I’m reviewing stock charts I’m initially looking at the stocks that I already own for a chance to do some covered call writing. Afterwards I look at charts of stocks that I don’t currently own for the chance to do some covered put writing. Both strategies are generally executed for the sole purpose of generating cash for future stock buys. As you can see, this becomes one of the engines that fuels the portfolio.
When I’m looking at charts of stocks that I already own, I’m looking for an MACD line that is above the zero line and starting to flatten out. This tells me the momentum of the stock price is waning. What’s even better is if the MACD has not only flattened out but started to fall sufficiently enough to cross below the signal line. In that case the momentum is beginning to deteriorate rapidly. It is at this point when the probability of successfully selling covered calls is high. If the MACD continues to fall and crosses the zero line then the trade will most likely be a success. At that point I can either buy the calls back at a price lower than I sold them or simply let them expire worthless. Either way this would be a successful trade.
When I’m looking at charts of stocks that I don’t own, I’m looking for an MACD line that is below the zero line and starting to flatten out. This tells me that the momentum of the stock price is improving. What’s even better is if the MACD has not only flattened out but started to increase sufficiently enough to cross above the signal line. In that case the momentum is beginning to improve rapidly. It is at this point when the probability of successfully selling covered puts is high. I should mention at this point that I do not sell naked puts. All of my put selling is covered with cash. Now if the MACD continues to increase and crosses the zero line then the trade will most likely be a success. At this point I can either buy the puts back at a price lower than I sold them or simply let them expire worthless. Either way this would be a successful trade.
So far, so good. In both cases above the trade was successful. The stock acted exactly like you expected it to. The options were sold, the stock moved appropriately, and money ended up in your account. And if the whole thing happened during the span of one work week, you’d have the weekend free for other things (like photography!). But what if it didn’t go as plan? That’s when your contingency plan or exit strategy is executed. I simply would not go into a trade like this unless I'd have thoroughly thought out my exit strategy and have it laid out well in advance of the trade.
I'll save my thoughts on exit strategies for another blog post.
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