Using Options to Trade Double Tops

Focus: OPTIONS

Potential double top formations can provide profit opportunities for option traders and technician Tom Aspray explains how two key technical tools can be used to take advantage of this important pattern.

Double tops and double bottoms can often alert the investor to major turning points, especially when they are observed in the weekly charts of a major market average or a key commodity like crude oil.

In November 2011 I discussed double bottom formations on crude oil (see chart), and at the time, many stocks were showing potential double bottom formations.

There are many articles on the classic characteristics of double top formations and the 1948 technical analysis classic Technical Analysis of Stock Trends from Robert D. Edwardsand John Magee is still a wonderful source on the topic.

The traditional interpretation dictates that the formation must be completed before action is taken. In the crude oil example it took a close above $90.52, which was almost 20% above the double bottom lows, to confirm the bottom and project a move to $105.33.

To confirm a double top formation prices often need to decline significantly from their highs and stops above the previous peak can make the risk uncomfortably high. Often times what appears to be a double top or bottom on the daily chart turns out to just be part of a continuation pattern. Traders who wait for the formation to be confirmed often have trouble managing their risk and therefore do not take the trade.

In this article, I will show you how combining the chart formation with two technical tools can allow you to take advantage of these situations using options.