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Any trader worth his or her salt is always looking for a new idea or a new “edge” – some way to profit from the markets. It might be a new indicator, a new oscillator, a moving average length we haven’t looked at yet, the ratio between Cocoa and Crude Oil (hey, I haven’t looked at that one yet) or anything else that just might help us to buy a little lower and/or sell a little higher. But what can also be helpful sometimes is to consider a strategy from “start to finish” – even one that is not guaranteed to generate riches beyond the dreams of avarice (although that would be nice too), in order to understand the bigger picture and how different steps are involved in the trading process. To wit:

Start to Finish

Step 1: A Market Signal

In Figure 1 you see a chart of SPY. On the chart we see that the 10-day moving average is above the 30-day moving average. This tells us that (at least for the moment) SPY is in an uptrend. At the bottom we also see that the 3-day RSI recently dipped below 36 and then ticked higher. We then waited one day, as the market often pulls back after a quick pop up. Based on this configuration we want to look for a bullish trade.

 

Figure 1 – SPY pulls back in an uptrend
click here for larger view

Step 2: Finding Stocks to Look At

Now that we have determined that we want to look for bullish stocks, the next step is to determine where to look. The possibilities are limitless. But for this example, we will simply look at stocks that just flashed a Wave 4 buy signal in ProfitSource. We can do this using the Precomputed Scans feature in ProfitSource as shown in Figure 2.

 

Figure 2 – Wave 4 Buys in ProfitSource

In this example we came up with a grand total of 5 stocks.

Step 3: Save Candidates to a List

The next step is to save these stocks to a list so we can look at option trading possibilities. This can be done in ProfitSource in Precomputed Scans by selecting “Action,” then “Save Search Results,” then giving the list a name. For this example we will simply enter an “x."

Next click on the “Platinum” icon, select “Market Scan Results” under “HUBB." Highlight “x,” then under Optionetics, click a Platinum List to save this list to. In this example, we already have a list in Platinum named “x,” so we will simply overwrite that list. Then click “Overwrite."

 

Figure 3 – Save a Platinum List from ProfitSource

The four stocks listed under Wave 4 Buy in ProfitSource are now available in Platinum in a list named “x."

Step 4: Find a Bullish Trade in Platinum

In this example we will simply look for a low risk option trade, so we will go into Platinum, select our list of Wave 4 Buys then look for bull call spreads. In Platinum we will:

1. Select Search Tools, then Find Trades III.
2. Next to “Selected Stock List” we highlight List “x."
3. In Smart Search Wizard we click on “Bull Call Spread”, and then click “GO."
4. Then click “Search."
   
   

Figure 4 – Find Trades III in Platinum

Step 5: Sort the Results

Once we get our list of trades we will:

1. Click on “Greeks” above the output table.
2. Then click on the heading “Gamma."

This shows the list of trades in Figure 5.

 

Figure 5 – Trades sorted by Gamma

In this example, the top trade involves buying the TBT June 46 call and selling the June TBT 56 call. To draw the risk curves and save the position we click on the trade itself in column 3.

Step #6 and #7: Assess the Reward-to-Risk and the Risk Curves

Figures 6 and 7 display the particulars for this trade and the risk curves. In this example we will buy a 4-lot, thus risking $908 on this trade. Our profit potential is $3,092, or 341% of our maximum risk.

 

Figure 6 – TBT Bull Call Spread


 

Figure 7 – TBT Bull Call Spread Risk Curves

Step #8: Manage the Trade

For this example we will set up the following trading plan:

1. If we are behind $500 on the trade we will cut our loss and exit.
2. If the position doubles in value we will adjust the trade to try to lock in a profit.
3. If no adjustment has been made we will exit the trade no later than 14 days prior to expiration.

By 5/7 TBT had advanced from 46.27 to 52.41 and our trade has an open profit of $1,312. We will adjust this trade by:

1. Selling 3 of our long 46 calls.
2. Buying back all 4 of our short 56 calls.
3. Buying 1 June 52 put.

This turns our formerly bullish trade into a long strangle as shown in Figure 8 and 9.

 

Figure 8 – Converting Bull Call Spread into a Strangle


 

Figure 9 – New Risk Cures for Adjusted Trade

By 5/27, TBT was once again very overbought. At this point we could either:

1. Close the trade completely and take a profit of $1,569, or;
2. Make another adjustment.

Since the title of this piece is “Soup to Nuts” we might as well adjust again and ride this thing until expiration. So in this example we will next:

1. Sell the June 52 put.
2. Buy the June 57 put.

This gives us the risk curves that appear in Figure 10.

 

Figure 10 – Second Adjustment

At this point we could simply hold the position until expiration knowing that the worst case is that TBT will drift back lower and we will garner a minimum profit of $1,284. By 6/10 TBT had reached another overbought level so we might have once again considered exiting or executing another adjustment. If we let this trade ride as is, then by 6/19 TBT was back down to 54.34 and the trade showed a profit of $1,284.

Summary

So is this strategy guaranteed to generate endless profits?  Hardly. Please remember that this is simply a step-by-step example designed primarily to get your own thinking moving. The process detailed here has many steps. All along the way different traders might have made different decisions regarding:

1. What constitutes a bullish (or bearish) market signal.
2. Which stocks to consider
3. What trading strategy or strategies to consider
4. What criteria to use to decide the best trade to take (gamma, delta, reward-to-risk, etc.)
5. How much capital to commit
6. When to exit or adjust a given trade
7. and so on and so forth.

So there you have some food for thought. The rest is up to you.

In the immortal words of Clarence Oddbody (Angel, 2nd Class), “Off with you, me lad [or lass] and be lively.”

Jay Kaeppel
Staff Writer and Author of Seasonal Stock Market Trends
Optionetics.com ~ Your Options Education Site

Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.

NOTES: 

To learn more about Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing, please click here.

To sign up for a free 1-month trial of Optionetics ETF Investor newsletter, edited by Jay Kaeppel and Clare White, you can do so by clicking here. 

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