Spread Trading: An Introduction to Trading Options in Nine Simple Steps

CHAPTER 30

Getting the Final Pieces in Place

“ Okay, let’s review a few things.” Nate stood to write on the white board that hung in Lon’s office.

“If we’re going to be successful, there are some fundamentals we have to have in place. Remember, first, that we’re looking for stocks that are optionable (that should be obvious!), that trade at a good volume every day, and that are largely owned by institutional investors. Then we have to do due diligence on the stocks we’re considering. To do this we want to look at a number of factors: sales growth rate, earnings growth rate, equity growth rate, ROIC, debt/equity ratio, and the intrinsic value of the company. As we said earlier, these numbers inform us about a company’s strength: they tell us if it’s growing and if it’s likely to continue to grow. And that tells us whether the market is likely to find this stock attractive. After all, if the market likes this stock, its price will grow simply because there will be demand for it. Now, none of these numbers guarantee that the market will like a stock and that its price will grow, but they do tell us what the market ought to like and therefore what stocks we ought to keep our eye on.”

“Right,” added Aaron. “Just because there are no guarantees doesn’t mean that we just guess and jump into the stock market willy-nilly. No, we always bring our brains with us. And, as we saw, another way to bring our brains with us is to look at the trends in the overall market. That’s important background ...