An Analysis of 3 Bullish Stock Chart Patterns

When stock market is bullish, there usually are a good amount of stocks that exhibit bullish chart patterns. Quite often, we have to choose one or two best stocks to trade out of many stock charts at a given day. This is exactly what happened to me today.

My bullish portfolio allowed me to take one more bullish position. So I ran my bullish search scripts in the last few days and could not find any chart patterns that were interesting to me. One of the possible reason might be my search criteria requires estimated daily volume greater than 150% of 20 day average trading volume. But this morning I found more than 3 stocks that showed bullish chart patterns and active trading volumes.  I was interested in the following 3 stocks mainly:

• AZN (A pharmaceutical company) with a cup and handle pattern;
• WYNN (Hotel) with a bull pull back pattern;
• MU (Semiconductor Company) with a bull flag pattern.

The stock chart patterns are drawn for illustration purpose in the image below.  Note the volume shown was intraday volume around noon time. The final volume was projected to be twice as much based on my rudimentary algorithm.

I liked the 6 week cup and handle pattern of AZN. But I found its option liquidity was an issue for me since the bid & ask prices for out of the money (OTM) call strike at Delta around 0.3 were over 20%. I decided to skip this option trade since my short call usually use this type of strike if I need to leg into a diagonal spread.

WYNN was bouncing up from both horizontal and up-trending support lines. But I saw a negative divergence in its MACD line. It suggested slower momentum for WYNN since the distance between the recent highs were shorter than that of the prior one. The stock also formed some level of over-head resistance in the prior two weeks. These were not desirable bullish signs.

Therefore, I settled on the 10-week long bull flag chart pattern on MU, which had very good option liquidity as well. I bought October 20 $27 Call for $4.21 as a position trade. The mental stop loss was set to $26.28 which was slightly below the last low in more than 3 weeks. My target price was $33.98 according to my trading spreadsheet. I plan to leg into diagonal spreads when the stock shows weakness (2 days in a roll with declining MACD & price).

In summary, here is the outline of my stock option trading selection steps. Hopefully, this multi-step procedure is not a stock analysis paralysis.

1. Verify recognizable price chart pattern that you plan to trade
2. Verify option bid & ask price spreads to be less than 20%
3. Review momentum of the prices (i.e. MACD indictor)
4. Verify bullish trading volume
5. Look for good relative strength
6. Look for bullish sector behavior

Did I make the right choice among multiple stock patterns? I used to have some concerns about the right pick or not. After year’s trading activities and the application of the principles of trading psychology as posted before (Additional thoughts on the successful mindset for high probability traders), I’m much more comfortable to face this uncertainty now. By following a solid trading process, I felt the profit probability is high although it’s not a certainty. My blog readers may have other thoughts. Please share with me if any.

Bought top performing emerging market ETF

As stock market shot up 2 days ago after the French Election, the 2 best performing emerging market ETF (EEM & EPI) that I have been watching were also outperforming as well. These two ETF's has been showing strong relative strength to SPY recently. EPI, the ETF for India, was particularly strong in the last couple of months. But the ETF's option interests was relatively low and the bid and ask differences are over 20%. So, I just purchased the ETF stock as it broke out near term resistance on April 4, after the French election.

I plan to hold these intermediate term positions for a few months. The stop exit will be somewhere they break 20+ day support that I identify along the way and the profit target exit will be the uptrend shows signs of ending or when the general market start to show weakness.

For EEM which has abundance of option liquidity, I bought the 2018 Jan 19 $38 Call (LEAPS) and plan to use my favorite diagonal spread strategy to manage this position. The stop & profit exit rules are similar to that of the EPI, with one extra rule of the profit exit: I plan to exit the position when the Delta of the LEAPS exceeds 0.80.

On the other hand, NFLX broke out with strong volume from a 3 month base today. I bought the September 15 $145 call as an intermediate term position as well. I'll follow up on these trades when I get time.

How many premiums are fair for short options?

As an option seller, I've been interested to know if the premiums I received for selling options are fair or not. However, there are so many factors that impact the premiums of sold options. To obtain a reasonable feeling of the fairness, I studied the TLT option spreads that I dealt with in the last few months. I used TLT short options of similar probability of success, same amount of capital requirement with the same width ($5) for the vertical spreads, and day to expiration around 56+/-7 days. In this way, I was able to reduce the number of variables for this comparison.

My goal is to receive 10% to 13% return on capital (premium$/width$5) for all ETF's that I trade. For the TLT options that meet my criteria, it means the premium should be above $0.50. Based on the above table, it looks to me the following conclusions are true for the options of similar probability and risks.

• Put premiums are higher than call premiums under similar conditions
• Premiums are higher when the short option bid and ask prices are narrower
• Premiums are higher when open interests are larger
• Premiums are higher when Delta differences between short and long strikes are larger
• Premiums are higher when the IV differences (Skew) between short and long strikes are smaller
• Premiums may not be higher with longer DTE in the analyzed range
• Higher IV of the option does not guarantee higher premium

My biggest surprise is that the higher IV's do not always provide higher premium or ROC. In October  turbulent trading, I could obtain higher ROC as IV was much higher in those days. But now, the IV of TLT is still high and yet its option premiums offer less ROC. I found other more liquid options (i.e. IWM) offer reasonable ROC (>10%) at the same time. The only reason I could find so far was the lack of open interests in the options. So I would conclude the lack of option liquidity means lower ROC for option sellers and the middle option price of bid and ask may not be fair.

In general, I believe this is one way for option sellers to estimate the fairness of option premiums as they use options of similar parameters for the comparison.

Adjusted May non-directional option portfolio for more neutral Delta

Market was selling off early today and my RUT position showed some damage as RUT dropped below $905 while the SPX gained some value as its position had some negative Delta. The following chart was intended to recreate the portfolio P&L situation before adjustments (but it's captured after adjustment since I forgot to capture it before adjustments). I also marked the P&L zone changes in the chart.

Since the recent dramatic market moves happened 3 weeks after the initial positions were established, there was no major damage to the portfolio and the Delta was close to -20 before my adjustment (not -36 at which point I usually make adjustments).

When looking for adjustment strategies, I felt the VIX shot up way above the Bollinger band and may come down later. So I did not use calendars alone and used a bear call vertical spread as well. After the adjustments, my portfolio has a significantly reduced Delta and acceptable Vega. The Theta is also significantly higher as well. My goal is to close the portfolio some time next week if market gives me a profit opportunity.

It should be noted that in this highly volatile day, my orders for the RUT spreads were all filled with market price quickly.

Hedging adjustments to April high probability option portfolio

SPX finally broke above 1555 level after a couple of tests. Market rise reached top band of Bollinger and Dow Jones Average has advanced for 10 consecutive days. A short term pullback is imminent. But my market neutral portfolio had a delta about -39 and price fell into the right slope of the P&L chart as shown below.

Both the SPX and RUT got into their coresponding adjustment zone. Since $VIX was at  low level of 11.60, I think it's very likely that VIX will not be much lower than that level in the next week of so. Thus, I chose calendars as adjustment strategy to hedge against possible upside movements. After multiple calendar adjustments, the portfolio delta was trimmed by 10 points approximately. The Vega changed from -130 to +285, a big bet on VIX not going down further for the next 2 weeks before I close the April inventory.

All the orders were filled quickly as expected, since the calendars are one or two months away. I could have used bullish spreads to reduce delta if I had more bullish outlook. Time will tell.

Completed April Option Inventory Build-up

Yesterday, I completed the April option inventory by purchasing the RUT double calendar. I initiated the April positions in the last few days, adding an iron condor position every other day. Since my market outlook is bearish at the moment, I used the DC to finish the April portfolio and reduced the portfolio Vega significantly to -76 as shown in the image below. I chose the April/June DC, because it offered flatter profit zone when compared with the April/May DC.

During the DC order execution phase, I started with $20.15 which was $0.05 above middle price. But my orders could not get filled for about 45 minutes by my broker who offers better commissions than TOS. I had to increase my bid price by $0.05 multiple times eventually, after waiting about 15 minutes for each bid. In the meantime, I could see occasional drop (lasted a couple of minutes) of the mid price in TOS to be $0.20 below my bid price. Overall, the ask price drifted higher at my ordering period. The price of RUT was creeping up and the Delta of the DC was -1.36. So the Vega (volatility) must be increasing quickly to raise the mid price of the DC. It seems to confirm that front month spreads are easier to be filled and multiple month time spreads (particularly several month away) are difficult to fill.

Closure of all Feb income option inventories

Yesterday Morning, market fell down and offered me a fair opportunity to close all my option premium selling positions. With about 7 days to index expiration and a Gamma over -8 which was way above my estimated range around -2, I decided to take whatever market offered and close all remaining FEB positions to eliminate Gamma risk even though the Delta was in the comfortable zone.

The remaining positions were all RUT IC & Calendars. I had to rush to my other work and close them as soon as possible. So I entered the closing trades which were the opposite trades to the original open trades as usually. All trades which were 5 cents above mid-price were executed smoothly, except one double calendar trade. This tough-to-sell double calendar had a RUT Delta of -36, as market was falling quick at the time. I had to reduce my ask price a few times to sell it. Thus I was not able to catch all the profit shown in the above chart which was taken before I started closing position. It took me about 30 minutes to close all trades.

This let my think about an optimized closing sequence for the monthly option inventory liquidation day. In the closing time of such a day, I'll need to review the intraday market trend on a 15 minute chart. If the market is trending, then I should close the damaging trades first before I close the profiting trades.

Without this procedure, the trades with potential to more profits are most likely to be closed first and the trades with potential to more losses will end up remaining alive.

Completed Feb high probability option income portfolio

Today, I finally completed my February high probability option portfolio by selling the RUT iron condor as shown below. This month's portfolio is made of all iron condors, because I still consider the market is within an uptrend. The portfolio Vega is about -200. It will gain $200 if VIX drops 1 point or SPX rises slightly over 10 points according to my calculation before (just one way for estimation). To make the portfolio market neutral, I also built a negative delta. In case market drops, the negative delta should help to increase the portfolio value, while the negative Vega causes the portfolio to lose value.

Today's order which was $0.05 below mid-price roughly was filled within 20 minutes (the mid price fluctuated during this time with a bias to the up side). Last Friday, I tried to order a RUT iron condor with slightly different strikes (10 points lower on put spread side). But it was a bit strange that it could not get filled, even if sometimes the mid price was more than $0.20 over what my order asked for. I checked the open interests and volumes of the strikes and saw the OI were over 1000's and volumes were in the range to 100's. But the TOS option sizzle index was 0.65, suggesting a low volume day due to holiday season.

Closed December RUT butterfly

Yesterday, I finally closed the RUT butterfly to exit all December positions with 2 days left for expiration. In the last week of the butterfly, I observed it to receive a 15% of max potential profit while RUT price was very close to the short strike of $835. It did not reach my target of 20% though. After a couple days of wiggling by the RUT, I had to sell this spread for a minor loss. The sell order which was 5 cents below mid price was executed immediately.

This trade reinforced my understanding of butterfly spreads. A normal butterfly would start to gain value in the last 7 days if market moves in the desired direction. A unbalanced butterfly would start to gain in about 2 weeks to expiration.

Unbalanced Butterfly spreads are good adjustment vehicles in bull market only if the portfolio expiration date is close to 2 to 3 weeks and one intend to hold the option positions close (10 to 5 days) to expiration. If there are more than 3 weeks, unbalanced butterfly spreads may not be good adjustment strategy, depending on its Delta and Theta mainly. If the adjustment trade brings little delta and theta, it's usually a bad adjustment since it does not impact the portfolio much at the adjustment time. For this reason, a normal butterfly is not good adjustment for the smooth option portfolio that I trade. In non-bull market, the unbalanced butterfly may not be good adjustment strategy due to its negative Vega.

Closure of November Option Inventory

With 9 days left for the expiration, I closed all remaining November positions to avoid any surprises after the election. The VIX increased yesterday while SPX rose ahead of the election. On the election day, VIX dropped about half a point at mid day time, causing my Vega positive portfolio to lose some value. Since the remaining positions were mostly calendars, the portfolio Vega was the major contributor for the small market moves. It was a little bit strange that all of my SPX closing orders that were $0.10 above mid-price got filled instantly.

Yesterday, I trimmed down my inventory to reduce risks. Closure of IC neutralized the delta and closure of the double calendar reduced the Vega as shown in the images below.

On the paper-traded 2 month portfolio, it has been very smooth up to now. I plan to close it around this Friday. It's very encouraging time-frame that requires my further study soon.

Triple Calendar Adjustment for Delta Neutral Portfolio

Market had a sell-off early in the morning, then rebound a little bit. Since SPX broke my support line around 1420 with higher volume and the SPX P&L curve was attacked from the low end, I decided to hedge my portfolio with adjustments.

After playing with a few strategies trying to neutralize delta, I settled on a triple calendar that reduced delta by 4. It is not an easy job to make large delta adjustments while maintaining a smooth P&L curve and it's not necessary to cut delta to 0 in one shot. I placed 3 separate calendar orders with $0.10 above mid prices. They all got filled in a few minutes.

The following image was simulated to record the P&L graph before adjustment and showed movement of break even points.

Note on the paper traded account for 2 month expiration option portfolio, there was no need for adjustments, as the delta and the graph did not show any needs.

Exit of October Option Portfolio On Profit Target

Yesterday, the monthly income portfolio reached the initial profit target with 15 days left. The portfolio was closed to eliminate risks. November portfolio will get started next week.

With the far OTM options in SPX, it took about 20 minutes to have one OTM spread to get filled even if the prices was set $0.20 above mid price. For RUT, one OTM option was too far to have a quote. I set closing price to mid price. Even if the spread could not be closed, there is extreme small chance to endanger it. In the end, the spread was filled as well, after may be one hour as RUT price moved.

It looks like if the option price is too far out-of-the-money (<$1.0 or $2.00) for SPX or RUT, the bid/ask   of the option price are likely to cause fill issues. Of course, for option sellers the spreads can expire worthless to get full profit potential, with extremely low probability of risks.

Bid/Ask Prices for RUT Butterfly

One day before RUT expires, I closed my RUT Butterfly spread for a break-even trade.

It was added as an adjustment to the smooth portfolio. At the time, I placed a limit order that was $0.05 above mid price and it was filled within 10 minutes, as market was fluctuating a little bit. Today, the bid/ask prices to sell the butterfly was wide. The bid was around -$1.10. Yes, it's a negative sign here. The ask was around $4 and mid was $1.20 to $1.70 for a while. My limit order of $1.65 was filled in about half an hour as RUT dipped temporarily.