Trading Strategies For Stock And Options Combination Trades

In this video I want to discuss our trading method stock and options strategies for a series of Facebook trades, including profit graphs for the risk reward of the trades. And I especially want to talk about how a combination stock option trading method reduces the risk for individual stock trades and short option trades.

But before starting the video, I also want to make some comments specific to price and trading indicators.

Although we do use indicators for trading, these are used as additional setup and chart reading information and not as trading signals.

Our trading method is first focused on significant chart prices and the price action and patterns that occur there – and when going into a new trading period, it is very important to bring the relevant prices from the left side.

 

Stock Option Strategies And Trades Review

Here is the trading chart that we will be discussing in the video for the stock option strategies and related trades.  You are look at a Facebook 60 minute chart, which is our position trading time frame – this is often synched with a 5 minute chart to get a look at more bars for entry timing.

The video will discuss the key price lines, along with options and stocks trading setups and patterns. Additionally discussed will be a number of profit graphs showing the risk reward for the different trades and trade adjustments.

Facebook Stock Option Strategy Trades

36.33:  retrace low after a price momentum divergence high – the divergence failed and the swing continued, making this line support

39.32:  double top momentum extreme [MEx cross] as resistance – MEx cross back

  • I was long at 34.50 before there was a price failure at resistance, I went short calls and long puts against the buy
  • This is one of the significant characteristics of the trading stocks and options together:
    • the option trade protected the open long
    • the long stock covers the short call option – to the extent that the stock and short call quantity is the same
    • the option trade would be an equivalent short trade if the long was exited before there was a sell setup

Option Trade:  -2 39.5c .75 +1 38.5p

Stock Option Profit Graph

  • Graph1 compares the stock option combination to the long stock only
    • You can see that the combination becomes a hedged position to the downside – but because of the 2 short calls, there is upside risk if there is a continuation breakout through resistance
    • However, there would typically be a stock add-on setup
    • Graph2:  Shows a stock add-on on a resistance breakout done at 39.50
      • 200 shares 37 average – compared to stock option
      • Trade is a covered call with the long put
      • The trade is still a hedged position – you can see how much less risk it has on a move down
      • But instead of having any upside risk the profit potential is capped
      • This profit curvature would change if there were more than 100 shares for each short call
      • Graph3 shows the stock equivalent short if the stock is exited at 38.50 – compared to a short trade done at the same price
        • There is greater downside profit because of the 2 short calls
        • But there is also greater upside risk because of the 2 short calls

When these counter option trades are done on confirmed failures at resistance or support, I sell 2 options for each option I buy – looking to trade into a short option strategy called a ratio short.

The objective in this trade would then be for a move to support, where 1 call would be bought against the 2 short calls and 2 puts would be sold against the long put:

  • Both of these trades would be done for a credit –vs- a probably debit [or well smaller credit] if both legs of the ratio spread had been done at the same time
  • A ratio spread has less risk, meaning a wider breakeven range, than a short option

Red Dot:  38.10 short

  • Method underlying setup
  • Initial reverse price channel break with mex flow
  • Triangle breakout pattern

Buy Call – Sell Put:  The short has move down to test support at 36.33 – it goes to 36.02

  • There is a double bottom pmd low
  • MEx extreme cross
  • +c -2p against the short stock – and complete the 2 ratio shorts

Options Trade:  +1 37 call .60 -2 36 put .70

Let me now show you what the risk reward of the short call has become as a ratio short

  • -39.5c .75 = b/e 40.25
  • +37c .60 -2 39.5c .75 = 42.90
  • Math:  width of spread added to short strike +/- debit or credit = 39.5 + 2.50 +.90 credit [.75 x 2 = 1.50 – .60]

Ratio Option Short Strategy

  • The tradeoff to this strategy is the smaller credit – .90 credit instead of 1.50
  • It may seem like a waste to be giving up the credit at 36.50 when there is a short breakeven at 40.25
  • But I would rather have the smaller credit and protect the open short – again a primary strength of stock option combination trading
  • And I want to manage my trades based on the method instead of having an opinion that a swing won’t reverse far enough to be a problem – it just so happens that you are look at the lows before facebook went up to 45.62, before I had another stock sell setup

Ratio Option Short Graph

Also note the risk-reversal aspect of a ratio short

  • Although this is a short trade – it actually profits on an up move from the long strike to the short strike
  • Before reversing risk at the short strike
  • But this risk is a giveback of profit to 42.90 – instead of an actual loss

Green Dot:  37.30 buy and reverse of short

  • The +c –p component of the ratio shorts protected the profit giveback of the short stock until this reverse was done
  • And then provided upside participation along with long stock
  • Remember that the ratio short profit goes up until 39 and the high of this chart period is 38.85

Chart High Position: long stock – ratio call short – ratio put short that was done at a credit

  • We have gone to a pmd high and I am looking to again sell calls and buy puts against the long stock
  • But nothing has been done yet
  • I am first looking for a pmd failure, which is a continuation breakout pattern to resistance – which has additional breakout potential there, because it is going to be hitting there as a triple top