In times when there is low stock volatility and a large, unpredictable breakout move is expected, a successful trader might consider making a strangle buy. A strangle buy is implemented by purchasing a call option and a put option on the same asset with the same strike price and expiration date. Because the stock is poised for a breakout but the direction isn’t known, buying a strangle can be an excellent stock market strategy.

A Buy Strangle affords the investor a limited investment risk, while offering an unlimited profit potential on a major move up or down. In such a strategy, the potential loss is limited to the premiums paid for the call and the put, as well as commissions. It is very similar to a Buy Straddle, except that the investor is purchasing options that are out of the money, which makes the potential loss smaller because the options are less expensive to purchase. A major move in either direction allows the investor to sell the opposite option and ride the one making the money, thus resulting in highly successful trading.

When technical analysis with Candlesticks indicates that a stock is trading in a triangle pattern, it is a prime target for a Buy Strangle. Frequently, with these types of stock chart patterns, an explosive move occurs near the tip of the triangle but the direction of the move is not readily known. Since the call and the put cover both directions of movement, a reward is quickly realized in this maneuver. Once the direction is known, the other option is liquidated and the investor can ride the trend. At this point, it is important not to ride the trend too long since time decay works against the trade in this position.

When Buying a Strangle, the put and the call options that are purchased are out-of-the-money. After identifying a triangle trading pattern with a tightening trading range, a position is initiated near the tip of the triangle. Because stock volatility is low, the options will be cheaper before a breakout occurs. Since this technique requires buying both a put and a call, buying before the spike is even more important. Strangle Buying has excellent risk reward ratios since the actual investment risk is limited and the reward is potentially unlimited.

As with all stock option trading strategies, there is risk, though limited, in a Strangle Buy. The actual purchase will be more costly since both a put and a call are being purchased on the same option. If the option fails to break out before the expiration date of the call and put, the trader will lose money on the purchases. Decay is also a factor working against a Buy Strangle, but it is eliminated by initiating a position before the breakout and quickly selling the option on the wrong side.

A Buy Strangle is an excellent tool to use in a stable market when technical analysis tools indicate that a stock is ready to break out of a triangle trading pattern. In such a case, the trading range is very tight and the stock is likely to make an explosive move. A Buy Strangles is one of several investment options that creates the potential for significant gains with limited risk of investment.

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Stock chart patterns have been utilized in the stock market for centuries. These recurring stock chart patterns create a huge advantage for technical investors by assisting them in identifying pattern trends. Depending upon the stock chart patterns, the pattern representation alerts traders to short term trend reversals, continuation patterns, market tops, false breakouts, and potentially explosive moves in price. Stock chart patterns continue to gain popularity in the trading community due to their ability to predict price movements. It is no surprise that many of the new stock market charting programs include search parameters identifying candlestick patterns. Serious investors recognize the value of candlestick stock chart patterns and benefit from the message each signal conveys. These  patterns reflect group behavior behind price movement and provide valuable insight.

Take the mystery out of stock chart patterns and learn to trade with Japanese Candlesticks. Each week we add a new article focusing on a specific candlestick pattern and unravel the secret behind upcoming price moves.

This week’s signal – Trading the Meeting Lines – A Candlestick Reversal Pattern.

MEETING LINES
 
Description

Meeting Lines (or Counterattack Lines) are formed when opposite colored bodies have the same closing price. The first Candlestick body is the same color as the current trend. The second body is formed by a gap open in the same direction as the trend. However, by the close, it has come back to the previous day’s close. The Bullish Meeting Line has the same criteria as the Piercing Line except that is closes the same close as the previous day and not up into the body. Likewise, the Bearish Meeting Line is the same as the Dark Cloud pattern, but it does not close down into the body of the previous day.

Criteria

1. The first candlestick body should continue the prevailing trend.
2. The second candlestick gaps open continuing the trend.
3. The real body of the second day closes at the close of the first day.
4. The body of the second day is opposite color of the first day
5. Both days should be long candle days.

Signal Enhancements

1. The longer the bodies, the more significant the reversal pattern.

Pattern Psychology

After a strong trend has been in effect, the trend is further promoted by a long body day. The exuberance is increased the second day with a gap in the same direction. But before the end of the day, the price has come back to the same closing price of the previous day. This indicates that the other sid eof the market has now stepped in. Another day, opposite of the predominant trend is required to demonstrate that the trend has reversed. The opposite colored body does not need to be a long as the first body. In every case, a confirmation day is going to be needed. The pattern has more strength if there are no shadows at the meeting point.

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Bullish Options Trading Strategies

• Buying Calls
• Selling Puts
• Bull Call Spread
• Bull Put Spread

Bearish Options Trading Strategies

• Buying Puts
• Selling Calls
• Bear Call Spread
• Bear Put Spread
• Put Hedge

Special Candlestick Breakout Options Trading Strategies

• Buy Strangle
• Buy Straddle

Neutral Options Trading Strategies

• Selling Covered Calls
• Sell Straddle
• Sell Strangle
• Calendar Spread

Options, the ultimate high risk investment vehicle. So it is thought by the vast majority. Why are options considered high risk? Simple. Most investors lose money in options. Statistics show that over 80% of all option trades lose money.

Why is this so? Because the odds are stacked against winning from the very start. First, as with all investments, but especially with options, the direction of price movement has to be correctly analyzed. This procedure alone is a major hurdle for the vast majority of investors. Next, the magnitude of the price move has to be correctly calculated; another procedure that has not been perfected by the average investor. On top of all that, add being correct as to the time element, the unaccounted aspect of most option analysis.

The combination of these three essential factors makes it extremely difficult to access an option trade correctly. And to add insult to injury, a premium is built into the option price. This premium reflects the speculative fervor of the market participants who think prices will move in their direction. The highly leveraged method of participating in the move creates a parasitic premium that is added to the true value of the option.

How do candlesticks turn un-advantageous probabilities into advantageous option trading profits? The essential factors of the signals can be applied to align the elements of successful option trades; signals, stochastics, market direction, etc. A few simple processes can be employed that will exploit the same factors that make other option investors lose money to put money into your pocket.

Direction

As you study candlestick signals, you will discover the improvement in accuracy will be quite noticeable. Under certain circumstances, the “accuracy” probability becomes extremely high. When all the essential indicators line up for a successful option trade, the signal showing strong buying in a stock, the stochastics below the 20 line, further confirmed by a bounce off a trend-line, and overall market direction, etc., an option trade can be executed. As in all the equations for producing a profit in an option trade, direction is the first consideration. Obviously, a clear and decisive signal is the reason for considering the trade in the first place. Knowledge of the reversal signals creates a huge advantage for exploiting short-term market moves. Especially profitable is the ability to pinpoint absolute bottom signals. Not only is there the benefit of purchasing an option at the ultimate lowest price, the premium or speculative fervor is also at its lowest point. This creates a double upside reward. As the price of the stock goes up, the option price goes up and the speculative enthusiasm expands the premium. Along with direction, the potential magnitude of the move has to be determined.

Magnitude

Analysis of a stock trade incorporates the potential magnitude of the price move. This involves analyzing where the next resistance/support might occur. Speed and magnitude of the previous move that is reversing is one factor. Congestion levels above the reversal area is another. Trend lines and Fibonnacci retracement levels are more considerations. But most importantly, the signal itself will dictate how strong the move could be. A major reversal signal, compounded with a gap up, will substantiate a much stronger advance than a secondary signal. The status of the stochastics should indicate how long the upside move can potentially be maintained. The analysis of the upside is going to dictate the ultimate trade strategy. And this has to incorporate the final element: Time.

Time

The weakest area of analysis for most option traders is the evaluation of time constraints. This is the area that human weakness is most likely to be involved. The direction and the magnitude not only have to be correct, they have to be correct in the proper time frame. For every day the option trade is in existence, time is working against the profits. This is experienced in two ways. First, the potential of the opportunity of a big up move lessens as the time for it to occur lessens. Secondly, as time diminishes, so does the investment fervor. Premiums also diminish as time passes away.

Time also becomes a major determinant in the type of option trade that should be established. Three weeks remaining before expiration will have a different trade strategy than one week remaining. A two-month option will have different strategies than a two-week option. The length of time to expiration dictates how to position the option trade.

Emotion is the major culprit causing option investors to lose money in 80% of option trades. Most “call” option buyers purchase the call due to some reason they think that will make the stock go up big. For example, let’s say the time frame is two weeks before expiration date. After the commitment of funds to the trade, the price does move up. Unfortunately, it does not move in the magnitude or speed to offset the diminishing premium built into the option price. Being correct in the direction of the move feeds the ego. The trade was correct. But if the magnitude of the price move was not great enough to offset the cost of the option premium, an emotional dilemma is created. Should the trade be liquidated or will the price move further, significantly more than its norm, between now and the remaining time to expiration? Gone is the original trade expectation and in comes “hope” for a positive resolution to the option trade.

Utilizing candlestick analysis emphasizes the discipline of placing as many controllable probabilities in your favor before a trade is established. Utilizing the steps for putting on a successful stock trade becomes all that much more critical when putting on an option trade. Each step needs to be scrutinized. Especially the final step, watching how a stock price will open. If the other steps have been followed, analyzing market direction, evaluating the sector chart, identifying a strong candlestick reversal signal, and seeing the stochastics in the proper area, then the final evaluation becomes an important element of the whole process – how is the stock price opening? The reason this step is vitally important is due to the time constraint on the option trade.

Implementing candlestick analysis into option trading greatly enhances the ability to make huge profits. Having the advantage of projecting direction makes option strategies simple. Identifying a candlestick “buy” or “sell” signal at the end of a trend allows the option trader to exploit option strategies that best extract consistent profits from the market, profits that take advantage of the 80% loss statistic. When other option traders are trading on less precise technical analysis, candlestick option traders can be executing trades precisely when the signals reveal the change in sentiment. Having the knowledge of spreads, straddles, and premium diminishing, expands the probabilities of creating the right option strategy for the right time and magnitude potential. The candlestick signals act as a guide for the active option trader. Learn the candlestick signals and the ability to extract huge option trade profits becomes a common practice.

Candlestick option trading programs have been developed to make “high” risk trading into a very low risk procedure. You can learn how to maximize the potential of an option move using different trading strategies. Having the foresight of direction the candlestick signals provide, the analysis of time and magnitude becomes simplified. The leverage of options produce inordinate profit potential.

Glossary of Option Trading Terms

When an investor is feeling bearish on the market, another good stock option trading strategy to employ is Selling Calls or Selling Bear Calls. This method is also known by the name Vertical Bear Calls. This is considered a bearish strategy because the trader profits if the underlying stock decreases in value. Basically, the strategy is to buy out-of-the-money call options and sell in-the-money call options on the same stock with the same expiration date. The plan is that the in-the-money stock closes lower than its strike price at its expiration date, and then the trader realizes maximum profits from selling calls.

When selling calls, the investor will experience maximum loss when the stock price increases above the higher, out-of-the-money call option strike price at the expiration date. This loss will be the difference between the two strike prices minus the net credit of the spread when it was originated. While there is risk involved, this stock investing concept allows investors to find profits even when the market is bearish by selling calls.

The downside of selling calls is that, while it is lower risk than simply buying put options, it has a limited profit potential as well. The break-even is at the lower strike price plus net credit. The maximum profit potential is when the stock decreases below the in-the-money call option strike price. In such cases, the investor will review his / her stock trading plan to see if the data and potential risks of the strategy are likely to create successful trading when selling a call.

For example, an investor wants to sell calls on ABC, Corp. The stock price is $39.875. The trader sells an in-the-money call option with a June expiration at a strike price of $35 for $5. At the same time, the investor buys a out-of-the-money call option with a June expiration at a strike price of $40 for $1.56. Selling a call such as this is a net credit of $3.44, spread of $5, or the difference between the costs of the two options. If the stock price is lower the in-the-money strike price on the expiration date, this would be a maximum profit of the net credit when selling the calls: $5.00 – $1.56= $3.44 x 1 contract (100 shares) for a maximum profit of $344. Conversely, the maximum loss would be if the stock closed above the out-of-the-money strike price on its expiration date: $5.00 Call Spread – $3.44 net credit received = $1.56 x 1 contract for a maximum loss of $156.00. Because the risk is low, the risk reward ratios when selling calls are still very good.

A successful trader will adequately investigate such a move prior to selling calls. That way, he / she can be assured that the trade has a high probability of being successful. As with any trade, the investor needs to understand the risks and potential profits involved in order to make a wise decision. Using a stock trading system such as Japanese Candlesticks, the investor has access to charts that are understandable and powerful data in the attempt to sell calls to make a profit.

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