Trading Options: Using Technical Analysis to Design Winning Trades, + Website

CHAPTER 10

The Elements of Design

As we get started in this part, there are a few terms that will help make the discussion easier to follow. If you were just trading stocks, then it would be easy. You would have only one tool, the stock itself. You either buy it or sell it. That is it. But when you branch out into options, it is like opening your toolbox and seeing a set of Allen wrenches. Yes, they are all wrenches, but there are now so many to choose from. You need to determine which one is the right one: put or call, which expiry, and which strike. Most options combinations start with a directional bias on the underlying stock and with a simple long or short call or put. The rest are added to manipulate leverage and manage risk to the trader’s requirements, as discussed in Chapters 8 and 9.

In this chapter we focus on the why of the particular options. Each option for a trade will have a purpose, so we will start by defining those purposes. With that done, we will digress a bit for a discussion on position sizing and setting stop losses. You will learn how these two are intertwined. At the end of this chapter, with the elements of design of the trade behind you, you should be able to identify each element for your trades. You should also be able to determine the proper stop loss and position size for each trade setup.

■ The Elements

Your first choice in developing an options trade setup is the one option that will be the key to the whole process. It is the call or put you want ...