Options 1k

Stochastics + Trend + Support/Resistance

Update Oct 2024: I am no longer using this strategy. After more than a year of trading, I was unprofitable (actually lost quite a bit of money). The strategy is fine in concept, but I was not able to get it to work for me. Either I wouldn't exit in time, or prices would gap up/down too quickly to manage it. The return was just not good enough for win rate I was getting. Leaving write up below for reference purposes.

This is an option selling strategy I adapted from Gin Lim over at passiveseeds.com

Basic overview #

Sell bull put spreads when stock is in uptrend, stochastics oversold, and near support.
Sell bear call spreads when stock is in downtrend, stochastics overbought, and near resistance.

Detailed Overview #

There's a lot more to it than that. Here are the detailed entry, exit, and sizing rules:

Entry rules #

  1. Probability of profit (i.e. Probability out of the money) > 75%, or Delta of sell leg < 0.25
  2. High liquidity (Open interest > 300)
  3. Tight Bid Ask Spread (< $1)
  4. Expiry in 40-60 days
  5. No earnings in next 3 weeks
  6. Initial profit target (premium / spread-premium) > 15%
  7. Stochastics oversold (< 20) for puts; overbought (>80) for calls
  8. Strike is below support for puts; above resistance for calls
  9. Price is in uptrend for puts (50ma>150ma>200ma); downtrend for calls (50ma<150ma<200ma); or well definied flat/sideways range
  10. Other: When overall stock market is volatile, look for Implied Volatility Percentile > 30%

Exit rules #

  1. Take profit at 50% of initial collected premium
  2. Take loss at 200% of initial collected premium (or 4:1 profit target)
  3. Take loss if support/resistance is broken (full candle below support/resistance)

Risk level + trade sizing #

1% risk per trade based on exit plan.

My current capital is about 30k, so my max risk per trade is about $300.

I must exit the trade when my net loss is at 200% of collected premium, and take profits at 50% (i.e. 4:1 risk/profit)

Since my max risk/loss is $300, my target take profit is $75, so my target for initial premium collected is $150.

Based on my rules, I need to win over 80% of my trades to be profitable. It's not exact, as I may take wins/losses early, but it's a general target to aim for.

Example

If the premium collected per option sold is $50, then I should sell 3 options (i.e. $150 collected).
I would take profits when I can buy back the position at $25 per spread (i.e. 50% profit target = $75 profit).
I would cut my losses when the price of the option reaches $150 per spread (i.e. $450 cost - $150 collected premium = $300 net loss).

Allocation #

For now, I'm going to try to limit myself to 5-10 total positions.

Summary / Pros / Cons #

The most important thing when using this strategy is to cut your losses. Everything falls apart if you don't, as I experienced.

You won't win every trade, so just take your losses and move on.

When sticking to the rules, I have been mildly profitable. Gin seems to do really well with this basic strategy.

The thing I don't like about this strategy is you have to look at your positions everyday to check if you need to exit or not. Not a huge deal, but you can't completely set-it-and-forget-it.

Also, scanning and picking trades based on support/resisntance levels can be pretty subjective.

Stochastic don't work well for stocks that are trending hard. For example, in a a strong uptrend, indicators always show "overbought", but you really shouldn't short a stock that is in a strong uptrend.