The understanding of how to trade options effectively does not typically include the subject of technical analysis. Information like this could be an important addition for the options trader since different market conditions warrant different spreads. In this essay, I will wade through the reasons why a trader would prefer to incorporate this genre of support into their option trading.
More advanced options traders can use the options pricing model to focus on certain elements of risk. But, the market's direction sometimes plays a role in the risk associated to trading certain option spreads. If the trader employs and options spread that uses call options, a bullish move would cause a delta of the call to increase. So, if a trader understands technical analysis he can select the spreads of a perform best under certain market conditions.
There are some advantages that are usually derived by looking for chart patterns when doing the type of technical analysis that the trader needs to perform when trading options. The head and shoulders, wedge and flag patterns typically fall under this heading. Patterns like the Gartley 222 and Elliott Wave can also fall under this heading. This can surely offer an advantage to those involved in option trading. These patterns are helpful because they assist the trader in determining the current mode of the market.
Once a trader understands the current mode or direction of a market they can choose the strategy that will perform best under those conditions. So, a chart that is showing a bullish bias would be better suited for a bull call or bear put spread. However, directionally based debit spreads can lose money if the market does not move much due to the time decay of the options used.
Looking at a price chart in this way can prove very helpful to traders because it helps them to see the area of support and resistance. From among the many option spread candidates that a trader may consider, he can include in his analysis to break even this of the spreads and how they correspond to the areas of support and resistance on the securities price chart.
When learning how to trade options effectively, traders may wish to also understand how they can effectively combine their new knowledge with technical analysis. While this may add a level of complexity to the many topics that traders already consider for their trading, they may find that it helps them in understanding why some trades are more successful than others. Once the trader has acquired this understanding about his results, he can better position himself to trade with more consistency. Finally, the trader has an additional holistic appraisal which enables him to associate option methods with technical aid for his option trading.
Sam Perdue has been actively trading the markets for over 13 years. He has written a computer program that helps traders analyze the stock, Forex, commodities and options markets using Fibonacci ratios, Elliott Wave, option pricing and nonlinear programming algorithms. For more information, please see our option trading software.
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