In past issues of The Option Strategist Newsletter, we have stated that we mainly utilize naked put sales rather than covered call writes in its traditional form – even for cash accounts. Several readers have asked not only how this works, but why we do this. So let us explain.
I was recently asked what guidelines I generally follow in my option trading. This is actually a rather thought-provoking question, especially when it regards something one does almost every day. In our feature articles, many useful general strategies have been given, but not assembled all in one place. After giving the matter some thought, it seemed like it might be beneficial to list some of the "rules" that we follow, either consciously or sub-consciously after all these years.
The market, as measured by the Standard & Poors 500 Index (SPX) has been in a steady decline since mid-October. There is resistance in the 1395-1410 area, and that must be overcome for the picture to become bullish.
Both equity-only put-call signals have now rolled over to buy signals!
The stock market got quite oversold near the recent lows. Now, Monday's strong oversold rally gave birth to actual buy signals from the breadth oscillators.
Today's early market action was a continued grind higher as further shorts were forced out of their positions. $SPX made the intraday high just below 1390, the upper end of resistance from 1380-1390. Around 1:00pm EST the Fed Chairman finished up a speech that apparently the market didn't enjoy. This triggered a wave of selling that brought the market down. Despite the sharp midday selloff, we still believe this rally may have some more room to the upside, likely a test of firm resistance in the area of 1400 and slightly above.
The stock market has continued to decline rather sharply this week. As a result, the support at 1370 was broken -- yet another major support level giving way. The next major support level is likely to be 1330, which is the lows of last July (see Figure 1).
The equity-only put-call ratios are moving to the higher levels of their charts now (Figures 2 and 3), and in a sense, that is oversold. However, they are clearly still on sell signals since they are trending higher.
The bears have finally managed to take control of the stock market, mostly due to some worries about upcoming economic and regulatory issues. However, the market has quickly gotten oversold, so a bounce may be forthcoming in the near future.
Put-call ratios are useful, sentiment-based, indicators. The put-call ratio is simply the volume of all puts that traded on a given day divided by the volume of calls that traded on that day. The ratio can be calculated for an individual stock, index, or futures underlying contract, or can be aggregated – for example, we often refer to the equity-only put-call ratio, which is the sum of all equity put options divided by all equity call options on any given day.
We keep track of “90% days” with a great deal of accuracy. A “90% up day” is, in its purest form, a day when advancing issues outnumber declining issues by at least a 9-to-1 ratio and advancing volume outnumbers declining volume by at least a 9-to-1 ratio.
The stock market, as measured by the Standard and Poors 500 Index ($SPX) continues to break down through important support levels. It is the close below 1395 that matters. This should activate targets as low as 1330, although it probably won't be in a straight line, for $SPX worked back and forth between 1330 and 1370 in July, and that range should provide some support.