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As a special service to our readers, I will be offering a free webinar on Wednesday. It will be for educational purposes only (with several live trades) to throw some light on my process and strategies when trading weekly options.
I say for educational purposes only because there will not be a follow-up on the trade. If you happen to take on the trade, remember, the key to keeping losses to a minimum is proper position sizing. Most of the strategies I offer are risk-defined, so you know at order entry how much is at risk. And knowing how much is at risk should give you a good idea what your position size should be per trade. But again, the following trade is meant for educational purposes only.
Another Weekly Options Trade
Let’s examine how a weekly options trade works using one of my two approaches to trading weekly options.
The overall market – more specifically the Russell 2000 Index as seen through the iShares Russell 2000 ETF (NYSEArca: IWM) – is in a very overbought state again, according to my favorite mean-reversion indicator, RSI.
Once I see confirmation of an overbought state in one of the highly-liquid ETFs I follow, like IWM, I immediately look for a trade.
Above is the weekly options chain for IWM.
With IWM trading for roughly $116.67 and in a very overbought state, I want to use a strategy like a bear call spread. A bear call spread will enable me a margin of error just in case the current directional trend – in this case a bullish trend – continues.
The next step is to choose the actual spread. I want to start by looking at the Prob.OTM column in search of a probability of success around 85%. If I were to choose the strike price closest to 85%, I would need to sell the 120 strike. However, since I only want to go out one strike wide, I would need to buy the 121 strike and that would only bring in a premium (bid price – ask price) of $0.09. After commissions, $0.09 doesn’t allow for much of a gain.
So, the next step is to move further up the options chain towards the 119 strike. This lowers my probability of success to roughly 78%, but it allows me to bring in an ample amount of premium to make it a worthy trade.
I can sell the 119/120 bear call spread for $0.18 ($0.57 – $0.39). By selling the strike with a slightly lower probability of success, I am able to make a return of 21.9% over the next 15 days. The margin of error on the trade is $2.33. Again, the decision always rests with how much probability of success you want to have on your trade. In this case, we are going with a 77.8% probability.
As long as IWM closes below the 119 strike at expiration in 15 days, the trade will receive the max profit of 21.9%. The break-even point is $119.18, which is the strike price of $119 plus the premium received of $0.18.
Again, given the extreme overbought nature of IWM, I am comfortable pushing forward with the trade – especially knowing that four of the 15 days are weekend days. So in reality I am only exposed to 11 trading days.
As I said before, I do things a bit differently than most people when trading weekly options. I do not make a trade every week. I wait for overbought/oversold extremes to enter the market and then I begin to look for a trade.
As I have said numerous times in the past, “For one to randomly select a trade based on the fact that it is Thursday or Friday, or any specific day for that matter, is irresponsible.” The market doesn’t work that way. I mean, what’s the hurry? Why do we need to make trades every week, especially for arbitrary reasons? We are in this for the long haul, so let’s take a more methodical, long-term approach.
Again, on Wednesday I will be discussing in far greater detail my approach to weekly options. If you would like to learn more, please click here.