Spotting Index tops And Bottoms by Leigh Stevens
Use these techniques to buy index options ahead
of market reversals.
There are two principal ways of trading
stock indexes with leverage. One is
using stock index futures, and the other
is using stock index options such as the
Standard & Poor’s 500 (SPX), the S&P 100 (OEX), and the Dow Jones index (DJX) options.
The futures markets do not offer as much leverage as
stock index options (nor do they offer the same
hedging opportunities), but trading futures does remove
the calculation of time premiums involved in
buying calls and puts. Because premiums for index
options get inflated quickly in a strongly trending
and/or volatile market, astute market timing tends to
be even more critical. You may be right on the trend
in index options, but still not make any money if
inflated premiums erode faster than the market moves.
In index futures like the S&P, I found that I could buy
and sell (short) breakouts and make money. However,
I would often lose on trades when I bought call
or put options like the OEX after a breakout move
occurred. To make a consistent and optimal profit,
needed to anticipate the price and time frame when
the market was making a significant top or bottom,
and buy index options ahead of market reversals. In
this way the premiums were reasonable, and I could
more comfortably hold a position for some time
when a move was especially strong.