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How Do I Trade Future Options Using Price Action

Published on August 25, 2012

How Do I Trade Future Options Using Price Action

August 25, 2012

Trading future options is a different strategic play vs trading options on equities or indices. While there are differences, there are similarities as well. Below article will provide basic idea of how and what kind of trading set-ups we are looking for when placing directional trades on Futures utilizing various option trading strategies. Please read and let us know if you have any questions, feedback via posting in the comment section.

Getting Clues to Market’s Next Move

Is it possible to trade or read the markets without indicators? Can traders really get a better grasp of market strength or weakness without indicators? Of recent years, more and more traders are going back to the basics and interpreting market direction or strength with only price movements. Although I do not make my trading decisions exclusively on price movements, I must say that I get a lot of clues about market’s next possible move from reading price alone.

As markets climb higher or tumble, they seldom move in one straight line. Markets usually move in a zig zag manner and it is this manner of movement that provides directional clues for alert trader. From this point on, for ease of reference, I shall refer to this manner of movement as market structure.

Market Movements

Timing the Markets Without Indicators

We often hear or read that markets will make higher highs in an uptrend and lower lows in a downtrend so how do we make use of this to time the markets? The principle is actually quite straight forward. For example, when a weekly chart is showing higher highs and higher lows, the daily chart is likely to exhibit the same behavior.

When the daily chart makes a potential higher low and starts to turn up, traders can use this as a timing tool to enter net long positions. In my own trading, I would be looking to establish bull put spreads or naked puts, depending on the market I am in.

Future Options Multiple Time Frames

If the daily and week charts are not moving in the same direction i.e. both do not exhibit higher highs and higher lows, I usually look for another market to trade. I want to stick with trending markets wherever possible.

For the more active trader, this principle can be applied using daily charts and intraday charts for more opportunities. Take note that trading in smaller time frames would also mean that the trader needs to be more nimble and careful not to overstay his welcome.

Early Warning System for Potential Trend Change

We often hear that markets will make higher highs in an uptrend and lower lows in a downtrend. What we seldom hear is how to use this principal to gauge market strength or the lack of it.

In an uptrend, we should see higher highs and higher lows. However, if we see the market making weaker higher highs, (and sometimes larger and larger retracements) the uptrend may be showing early signs of exhaustion or even a potential trend reversal.

Future Options Early Warnings

Similarly, in a downtrend, if we see the market making weaker lower lows and stronger lower highs, we should be alerted to a weakening bear.

FutureOptions Early Warnings 2

I use this knowledge to help me minimise risks. Once I detect the weakening of a trend, if I have open positions, I will either scale out or at least look out for any signs of trend change. If no trades are initiated yet, I usually stand aside and observe if the market will actually change trend or just pause before resuming the original trend. I want to participate only when the market trend becomes clearer.

Making Tight Risk Management Possible

We can also make use of market structure to place relatively tight stops. This is especially helpful for the more careful traders. Say I want to catch the market moving up in an uptrend but I want to be very careful as market environment is more volatile than usual. I will establish bull put spreads as the market makes a potential higher low on the daily chart. If the market moves lower after I enter the trade and break the level earlier assumed to be the higher low, I can exit my trade immediately.

Future Options Tight Risk Management

Putting It All Together

Summarizing the above, it means that I prefer to follow trends and try to ride them for as long as I can. I try to avoid non-trending markets with tight ranges. By following the principles of market structure, I do my best to minimise risks by keeping stops tight. Above all, I tell myself to wait patiently for a trend to develop. After all, we only need a few good trends a year to reap satisfying results.

Futures markets especially Corn, Wheat, Soya and Crude have been buzzing rather actively during past few months. As part of our Income from Future Options (IFO) service, our strategy has been to wait for the best set-ups that increases our probability of success and as soon as our set-up emerges, then we go for it via appropriate option trading strategy to maximize gains while reducing risks. (Try IFO FREE for 14 days, thereafter US$97/- per month (price revised upwards from July 22,  2013).

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