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When I find stocks with strong price support, I love to use a specific options strategy to take advantage of time decay.

In other words, an options trade that profits from the passage of time as the share price stays above this strong support area over a period of several day.

Today, I am going to show you what I am seeing on the long-term charts of Zoom Video Communications Inc. (ZM) that has me so excited about the bullish trade I am currently waiting patiently to enter in this stock.

Zoom Video Communications, Inc. (ZM) was one of the biggest beneficiaries of the Covid 19 crisis, with demand for its online conferencing technology attracting enough interest to drive the company’s share price roughly 700% higher in 2020 alone.

Since the 2020 highs, though, the stock has been in a downtrend that may have bottomed earlier this month.

Here’s what I am seeing that leads me to believe this.

Figure 1 shows a weekly chart of ZM since its IPO in 2019.

Figure 1

The support I am seeing is significant, as it is made up of the following combination of very important technical tools:

  1. The Volume Weighted Average Price (VWAP) that has been Anchored at the stock’s IPO price (visit: https://school.stockcharts.com/doku.php?id=technical_indicators:anchored_vwap to learn more about the Anchored VWAP).
  2. The 61.8% Fibonacci retracement of the entire move from the stock’s  all-time low to its all-time high.
  3. The June 2020 through August 2020 price range.

To repeat, this is a powerful combination of support levels that, along with the extremely oversold weekly price action that developed earlier this month, gives the stock some of the best odds in months that it has found support that can hold for a long period of time..

I don’t like to chase rallies, so I’m being patient

Short-term, Figure 2 shows the stock has been rallying above the 200 hourly moving average, which is a key level above which new buyers are starting to enter.

Figure 2

Figure 3

However, I don’t want to chase prices here so I’ll wait for a pullback before entering this trade.

In order to prevent chasing this stock higher, I’m using limit orders to control my trading emotions.  

And to prevent waiting too long, this purchase order will expire at the end of day today (10/20/2021).

Here’s a trading lesson on how I am playing this trade.

Trading Lesson: Time Decay

As Figure 2 also shows, I am trying to sell a vertical put spread, the details of which are shown in Figure 3, that will benefit from the passage of time, otherwise known as time decay, as the stock remains above the $260 area.

Time Decay is a great tool for option traders, especially option sellers!

Time decay is a measure of the rate of decline in the value of an options contract due to the passage of time. Time decay accelerates as an option’s time to expiration draws closer since there’s less time to realize a profit from the trade.

3 Key Aspects To Time Decay:

Time decay is the rate of change in value to an option’s price as it nears expiration.

Depending on whether an option is in-the-money (ITM), time decay accelerates in the last month before expiration.

The more time left until expiry, the slower the time decay while the closer to expiry, the more time decay increases.

How Time Decay Works:

Time decay is the reduction in the value of an option as the time to the expiration date approaches. An option’s time value is how much time plays into the value—or the premium—for the option. The time value declines or time decay accelerates as the expiration date gets closer because there’s less time for an investor to earn a profit from the option.

Figure 4 shows a chart of Time Decay :

Figure 4

You see, the closer you get to expiration the faster the option value races towards 0% value!

Vertical spreads are easy to apply and offer favorable success probabilities

When it comes to learning multi-leg options strategies, vertical credit spreads are among the easiest and are therefore a great place to start.

Why are they relatively easy to comprehend?

Because they include either selling one put and buying one put (bull put spread) or selling one call and buying one call (bear call spread), and only include options of the same expiration month.

The maximum gain that can be earned from a credit spread is the net credit, realized when both options expire out of the money.

The maximum loss potential is the difference in strike prices – net credit. Realized when both options expire in the money.

Conclusion

The best support areas are those that are made up of multiple technical levels. Since ZM is rebounding from a combination of strong technical levels, I want to take advantage of the fact that price is likely to remain above these technical levels for a while by using an options strategy (the bull put vertical credit spread) that will benefit from the passage of time.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

If all you see from a trading guru is profitable trades and 100% gainers, it’s probably a scam. At Raging Bull, I’m committed to full transparency. Real trading involves hits and misses. The best traders in the world usually have a win rate of around half their trades.

Last Friday, I got absolutely smoked on one of my most profitable trading strategies. I’d been milking Friday lotto options trades in AMAZON (AMZN) for months by following the smart money. You can read about the strategy and how I made $24k last week here 

 I was going to keep riding this trade until it didn’t work, and on Friday, I was on the wrong side, as were the smart money market makers leading to an outsized move in AMAZON (AMZN).

The Smart Money

Market makers, the guys who provide most of the liquidity in the options market by sitting on the bid and offer, are like the house in the casino. And most of the time, the house wins because the odds are in their favor. There are some folks who are often called the “smart” money— and as an active trader, I want to know what smart money is doing—to stay competitive in the market.

I do this by looking at the options chain and open interest. I look at the open interest at various strike prices to gauge how market participants are positioned and what the smart money is likely to do.

For example, I have been watching and trading AMAZON.com (AMZN) very closely over the past several weeks. And what I’ve noticed is over this recent time period is AMZN has tended to sell off or at least stay range-bound as the smart money market makers look to collect as much options premium as possible. By reading the options chain, I can see where a large number of options contracts have been sold and thus the range which AMZN might trade in.

This strategy has been working for me for weeks, and I was reading AMAZON on Friday lotto options like a book! In fact, I published the strategy here last week. Now I am no conspiracy theorist but it’s interesting that the week after I published the strategy, it completely fell apart and led to a Gamma squeeze.

A Gamma squeeze happens when the smart-money market makers are on the wrong side of a trade and a forced to hedge their bets by buying stock as price moves against them. Here is my Friday lotto options plan which I traded:

AMZN

Looking at the chart on Amazon.com, Inc (AMZN), I believe that sellers are going to start to come in near the recent pivot level and the 200 hourly moving average that is lurking above the current price.  

In order to play this price action, I want to look at strategies that can not only profit in a downward trend, but also a sideways trend. So instead of buying puts, I’m going to sell a Credit Call Spread.

So, what’s my plan here?

My Trade Details: Selling the $3310/3320 and $3330/3340 call spreads. And I plan to add to the $3330 spread tomorrow near the open.  

Why on earth these contracts?  

Look at the outrageous amount of calls sold above $3300 that expire tomorrow. I think there is very little chance that AMZN closes north of $3310 and it is remote that we see $3330 tomorrow.  

This is another perfect setup week and I am going in big on the Friday AMZN fade tomorrow.

I’d been making this trade for weeks, and so had the smart money market makers. So when AMZN got above 3330 and held, there was an EXPLOSIVE move higher! Why? A Gamma Squeeze works like this:

There were tonnes of options sold above 3300. Usually, it’s in the smart money call sellers’ interest to keep the price at or below these levels to collect all the premium paid by the call buyers. A lot of the time, they are able to do this, as has been seen over the previous weeks. However, when the smart money call sellers lose control over the stock due to breaking news for example this can lead to an even bigger move against them, especially on Friday Options expiry.

1min chart of AMAZON intraday on Friday October 15

So as we see in the chart above, as AMZN began to hold above 3330 this meant that all the market makers that had sold the calls above 3300 were now underwater. In order to prevent even further losses, Market Makers will buy back stock to hedge the options they sold short, which leads to a gamma squeeze and an even bigger move than expected. Then momentum players and algorithms can begin to buy even more calls at cheap prices on a Friday, and this vicious cycle usually continues further than most people expect.

Here are my trades in AMZN:

Once AMZN started to hold over 3330 I knew I was in big trouble. However, I understood that there could be a gamma squeeze and quickly adjusted my strategy. I took a huge loss on the calls I was short and held the calls I was long. This is a risky move in that if there is no gamma squeeze, I can lose big on both positions, but I understood the uniqueness of this situation and happened to make the right call. I was able to turn a huge loss into a slightly green trade in one of my accounts as AMZN ripped higher and the calls increased in value. However, I left the call spreads alone in my other account as a precaution and ended up having to eat the loss as AMZN squeezed.

I was able to make the best of a bad situation but have to take the loss on the chin and move onto the next trade. This was a great example of when the big money is trapped and leads to outsized moves against them as they are forced to hedge/liquidate their positions. Joining the pain trade is a great trading setup!

Bottom Line

Real trading involves hits and misses. The best traders in the world usually have a win rate of around half their trades. A trader’s job is to keep doing what works until it doesn’t. On Friday, one of my best trading strategies that I’ve been using for months finally stopped working. The smart money market makers on AMZN were trapped, and this led to an epic squeeze/ breakout. I was caught with them but managed to make the best of a bad situation by adjusting my trade and limiting the loss. However, I still had to eat the loss on some of my position as AMZN ripped to close at the highs of the day. On to the next trading setup!

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

I love structuring my trades using options. I use a number of advanced options strategies to control my risk. One of the simpler strategies I use is to sell puts naked on lower-priced stocks. I do this on small-cap stocks that I don’t think will go much lower. You see, the beauty with selling puts is, the stock doesn’t even need to go up for me to have a great trade. So long as the stock stays sideways, the trade will work due to time decay or Theta. I recently made a great trade in SPHERE 3D CORP (ANY) by selling puts that expired worthless, leaving me with all the premium!

Time Decay or Theta is a very important concept when it comes to trading options, and this knowledge can give traders an extra quiver in their trading arsenal.

Theta

An option’s price is made up of intrinsic value and time (extrinsic) value. The closer an option gets to its expiration date, the faster that extrinsic value erodes. That rate of decay is the option’s Theta. It represents the amount of time value that will be lost the next day.

The closer the option gets to expiration, the bigger Theta gets. And, this increase happens at an exponential rate. Here’s an example of how Theta might erode an option’s time value.

And, here’s what that would look like when plotted on a graph.

Now, whenever you buy an option (call or put), your position has a negative Theta. On the other hand, when you sell premium (call or put) you have a positive Theta. For an option buyer, Theta works against you, and for the option seller, Theta works in your favor.

Three critical aspects I analyze before making a trade are price, volume, and time. Most beginners only focus on price, which is one-dimensional. Adding the concept of time adds a third dimension to how a trader can view markets. This added dimension is even more important when trading options. 

The Smart Money

The market makers selling options are considered the “smart money.” They make a living selling options to retail speculators. Although selling options might seem risky at first, being an options seller has an added benefit. And that is Theta. You see, as Theta decays the options seller receives this premium, it is like collecting rent. Every day that the stock stays below that particular strike, the price of the options will decay due to Theta, and the options seller will be in a stronger position. The option seller benefits from the passage of time, not only price. 

By selling options, I can benefit not just from the movement in price but also the passage of time, just like the market makers. 

One of my favorite trading strategies is selling puts on lower-priced stocks. It takes advantage of the market’s tendency to move up for longer than it moves down and allows me to be right on a trade even if the price of a stock doesn’t move higher when I think it is likely to do so. 

On higher-priced stocks, I usually sell spreads to control my risk. So I would sell one put option close to the money and buy a put option further out of the money. This protects me from unexpected drops in the price of a stock and from outsized losses. However, on lower-priced stocks that I like, I sell puts naked. My risk is defined in that the lowest the stock can go to is 0, and these events are rare. I do extensive research to make sure this is unlikely to happen, but I am a big boy and understand sometimes I will have to take a big hit if something unexpected happens. I am willing to take this extra risk so that I am able to get the added returns by selling puts naked over selling spreads. 

The Fundamentals

 In June, Sphere 3D Corp. (NASDAQ: ANY) entered into an Agreement and Plan of Merger with Gryphon Digital Mining, Inc. (“Gryphon”), a privately-held company focused on the mining of bitcoin using renewable energy. Upon completion of the merger, the Company will change its name to Gryphon Digital Mining, Inc. Given the recent strength in bitcoin and cryptocurrencies as well as the focus on renewable energy, I liked the company’s fundamentals in the short term. It was also a popular social media stock that I felt people would support so long as bitcoin held steady. Moreover, I really liked the chart.

The Technicals

Daily Chart of ANY, I entered the trade on September  20th highlighted by arrow

I’d been stalking ANY for a while. In early September, the stock ran to over $10 but could not hold above. It had started to consolidate with resistance at $7.50 and support at the $5.50-$5.70 area. I liked the stock, and the story, so I was waiting patiently for a pullback into support before taking a position. Patience and great entries are key, so when ANY touched $5.50 and bounced off the 30-day moving average (MA) I entered the trade.

The Trade

I sold 100 of the $5 puts expiring October 15th for 63cents on September 20th. So long as ANY traded above $5 over the following few weeks, I would pocket $6,300 on October 15th, and this would be mostly due to Theta. I thought that this was a very high probability trade in that $5.50 was a great support level, and I thought it was unlikely that ANY would go much below $5 in this time period. Those options expired at 0 so I pocketed all of the $6,300 premium I had received, as ANY closed at $8 on Friday. 

Bottom Line

One of the simpler strategies I use is to sell puts naked on lower-priced stocks. I do this on small-cap stocks that I don’t think will go much lower. By selling options, I can benefit not just from the movement in price but also the passage of time, just like the smart-money market makers. On lower-priced stocks, I am willing to take the extra risk so that I am able to get added returns by selling puts naked over selling spreads. The lowest a stock can go to is 0, which is unlikely and one I am willing to take over the long term. A great example of this strategy was my trade in ANY which worked to a T!

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.