Tuesday’s Stock Option Trading Strategy!
My option trading strategy is to sell out of the money option spreads.
Yesterday, the market took a breather after a big run up last week. That 5-day rally was the biggest we've seen in over a year. It is normal for the market to retrace after a move of that magnitude.
When the market was not able to add to the early gains last Friday, the selling pressure picked up throughout the day. Monday, the market pulled back and the bid to the market weakened.
In yesterday's commentary, I outlined why I thought the market would pull back going into the Unemployment Report Friday. I believe we could see an increase in unemployment and a negative market reaction. Some analysts are calling for a half point interest rate reduction by the Fed. A weak employment number will support their case.
If this scenario unfolds, I believe fear will dominate the marketplace and bad news will be construed as such. I feel that many traders believe that any future rate cuts will only have a marginal impact.
Whether it is a rate cut by the Fed or a "mortgage reset freeze" by Treasury Secretary Paulson, the market is looking for help. It does have year-end strength on its side, but not much else.
In the absence of economic/earnings news, the market will search for a direction.
The early momentum today is down and I believe that will continue. The market should be able to find support at SPY 146.
Sell out of the money call credit spreads on stocks that have been in a downtrend and have recently bounced with the market. Sell out of the money puts spreads on the strongest of stocks that did not depart from their uptrend during the recent market decline. If the market breaks above or below the dotted support/resistance lines drawn in the chart, buy in the losing spread positions and wait to see if there is any follow through. I don't believe the market will break out of this wide range. Consequently, selling out of the money premium (while the option implied volatilities are high) is the strategy of choice.
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