Options Trading 101: Why I Never Buy or Sell That First Big Move

05/06/2015 8:00 am EST

Focus: OPTIONS

Bob Lang

Founder and Chief Analyst, Explosive Options

Bob Lang, of ExplosiveOptions.net, explains how he uses the beginner options trading strategies of being patient and waiting to see what the next move might be before he enters a trade and highlights why he never buys or sells on a stock’s first move.

In the game of trading, there is always a rush to be the first one in or out of a stock’s huge move. It’s great fun and a huge ego boost to be able to call that shot, whether it’s a bottom or top.

There’s just one problem: These trading decisions are often impulsive and made without much thought. When a stock plunges, it may seem appropriate to stick your hand in and take a slice or big chunk, even if you don’t understand the technical damage that could be taking place. On the flip side, a stock that is rising may be a smart pick, but we have seen numerous fake-outs lately that have burned buyers who have jumped in too quickly. In addition, shorting or selling a breakout may also be a premature move, you don’t know until you run technical analysis.

This brings me to my main point, which is a huge options trading 101 topic. I never buy or sell on a stock’s first big move, and here’s why:

If you want to trade options for income over the long-term, you need to have patience. I wait for confirmation of the move first and I look for positive signs from indicators that provide more confidence and higher probability odds.

Afraid you might be missing out? You probably are not missing a thing. I have learned that I don’t need to be the first one in, because it may be far too early. You see, a first move down is driven by panic and it is rarely the only selling that occurs. There will be aftershocks when reality sets in. Likewise, a huge breakout will be followed by some commitment that buyers are serious about more upside to come.

I’m perfectly okay with being late to the party, because I know that if a new trend is taking place, I will have plenty of time and room to get on board. If a new range is being established, then I can very easily pull the trade out of my portfolio with minimal damage.

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This strategy has paid off for us recently. Just last week, Twitter (TWTR) posted some disappointing earnings. On Tuesday their stock plunged and a lot of people were out there grabbing whatever they could while the stock sat in the low 40s, willing to take advantage of this absurd selloff.  While it may have been absurd, it was surely not finished; the stock continued to go lower until it finally reached depths on Friday that had not been seen since January (see above chart).

In a flash, Twitter’s 46% gains YTD were wiped out. Those buyers who jumped in when Twitter was in the low 40s? They’re now under water by at least 10%. Oh sure, the stock will bounce back at some time, but would you want to wait for it to bounce just to hit break even? Of course not. We are here to make money.

Oh, I suppose Twitter won’t be down this low (high 30s) for too much longer, but my point is that if those jumpy buyers had exhibited just a little patience and waited one day, they would not be in the hole right now.

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Here’s one more example for you: We had our eye this past week on Chesapeake Energy (CHK), which had been showing some robust volume and strong option flow. Much of that activity was concentrated on Tuesday and Wednesday, yet it did not confirm a price breakout until Thursday and Friday. I entered option positions on April 30 (I bought July 15 calls) when the stock showed some great relative strength in a weak tape. Friday’s rally confirmed that a bull trend is in place (see above chart).

Waiting for a price confirmation and turn in technicals gave me the added confidence that this trade would work out. And it is working out nicely: So far we are up 35% in this trade in just under two days.

There are many more examples of recent breakout failures (looking at you, Google (GOOG) and Amazon (AMZN)) and breakdown failures, but I think you get my point by now. Using options trading 101 knowledge—being patient and waiting to see what the next move might be—will ensure you have better odds of following a trend to a profitable trade.

By Bob Lang of ExplosiveOptions.net

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