Determining trendlines and setting strike prices

Determining trendlines and setting strike prices

Jun 3, 2020 | 0 comments

Both the market and individual stock prices move in trends and whether that trend travels upwards (bullish), downwards (bearish), or sideways (channeling), it can be assumed that prices will move in the direction of that trend until that trend ends and the direction of price changes. 

Once you know the direction towards where the market is moving, and more importantly, predict when the trend might shift direction, you’ll be able to more easily manage your trades. Trading with the trend is kind of like swimming with the current: It requires less effort. 

Understanding the relationship between trends and options pricing can give an edge to your trading and help you limit risk. Markets trend only a small percentage of the time, but when they do, that’s when you can be the most profitable. 

Whatever your options strategy might be, you are going to want to determine the direction of the trend and buy a call option or sell a put option when the market is set to go up, and buy a put option or sell a call option when the market is set to go down. 

On a stock chart, trendlines are drawn along two price highs or price lows (at least). As more prices touch the line, the stronger the trend becomes. 

Once a trendline is defined, you can better determine your entry point to the market or exit point from the market based on the higher or lower historical price. This entry/exit point is known as strike price. Setting the correct strike price, or the price at which a put or call option can be exercised, is a key decision when selecting a specific option, since picking the incorrect strike price can translate into losses and increased risk. 

How to trade the trend?

Trendlines can essentially give you a yes/no nod as to whether the price of a stock is expected to close above or below a certain strike price at a specific time, so if you believe a trendline will provide support, you may want to buy a strike at the line or sell an option for resistance below the trendline as it recovers from previous closes. 

A put option strike price at the stock price or above it is considered safer than one that is below the stock price, as is a call option strike price at or below the stock price. Trading strategies based on trendlines advise that pullbacks towards the trendline are good buying opportunities. 

When you are looking at trendlines, be mindful of the term of the trend. If short term, medium term, and long term trends are all trending in the same direction, then your chances of generating profit are greater. Like swimming with the current. 

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