Nearly every trader has been bearish on a stock or exchange-traded product (ETP) before. I, for sure, have been bearish on names before. However, it’s pretty risky when you just short a stock or ETP outright. Shorting a stock, or short-selling, involves borrowing shares and then selling them immediately, with the goal of picking them up again later at a lower price, returning them to the lender, and pocketing the cash difference. But shorting is riskier than taking a long position, or simply buying stocks when you’re feeling bullish.
That’s because theoretically, stocks have unlimited upside. In other words, you never know how high a stock can run. Moreover, it’s hard to figure out how to time a short. When you’re learning how to trade options, understanding how to use an indicator to signal when to buy put options is crucial.
There are a wide variety of technical indicators that investors use to judge when different types of securities should be traded in order to make the most profit. Well, we use a simple moving average crossover to signal when we should buy put options on a stock. The best part: you could potentially more than double your money on options with just a small move in the stock. That said, let’s take a look at how to use the “money pattern” and put options to play for a down move in a stock.
Money Pattern and Put Options
If you’re looking to play for a down move in a stock, shorting it outright is dangerous. You never know how much you’re going to lose if the stock goes up. However, when you buy put options, you know exactly how much you would lose if the trade didn’t work. You see, the maximum loss when you’re long a put option is just the premium paid. For example, let’s assume you bought 1 put option for $150 (keep in mind the multiplier is generally 100 for equity options). Your maximum loss is $150, you can’t lose more than you paid for the option.
This is the beauty of using put options to short stocks. Moving on, you’ll need an indicator to let you know when to buy a put option. You can’t just go out and randomly buy put options because you think the stock is “up too much.” This is just gambling without a strategy, and it’s an especially dangerous way to approach the market. If you’re moving into a space where you’re looking to short stocks by buying put options, then you need to have a proven strategy undergirding everything that you do.
Our community has been using moving average crossovers to generate high returns on both the long and short side. Tracking patterns is a critical investment skill, whether you’re working with options trading, day trading, or swing trading. With that in mind, let’s take a look at some examples of how to use the “money pattern” when trading put options.
How to Trade Options – Money Pattern Put Options Example
Moving average crossovers are extremely helpful in timing a trade. For example, I used a moving average crossover to signal when to buy options before. Weight Watchers International Inc (WTW) was a really strong stock and nearly doubled in a few short months. I figured it was extended and I would wait for the “money pattern” to show up before I bought put options.
When I saw the 13-period simple moving average (SMA) cross below the 30-period SMA, I decided to buy some WTW put options.
In the meantime, check out our guide to understanding options charts.
Now, I did take a little bit of pain in the WTW options, but I figured there was some resistance at the highs, so I changed my plan a little bit and held onto the options.
Thereafter, the 13-hourly SMA broke below the 30-hourly SMA and we could clearly see the downtrend.
Once this pattern works, the stock could run lower, and sometimes, it’ll drop further than expected. I locked in some profits in WTW and sold half for a pretty nice gain. With just a few percentage point move, the options exploded in value.
The indicator and some patience paid off. The WTW puts came out to be a nice winner and I was up over 100% on the trade at one point.
The Bottom Line
If you’re learning how to trade options, the money pattern is a useful technical indicator that could potentially lead you to some hefty gains. Keep in mind, the money could be also used to signal when you may want to buy call options too. There’s two sides to the money pattern. Now, it’s going to take a lot of practice and learning how to recognize this pattern. Moreover, you’re going to need to learn a bit about options too. However, once you get these two things down pat, it won’t be rare for you to more than double your money.
Jeff Bishop is lead trader at WeeklyMoneyMultiplier.com and widely recognized as the Mensa Trader. He runs short-term trading strategies, using stocks, options and leveraged ETFs.