Trading Options on Breakouts?

[darkcloudcover]

Hey traders, wondering if I might get a little "guidance" from someone who "knows the ropes" on how to trade options on breakouts... someone who does it and is good at it.

I'm trying to get my arms around the best kind of option strategy to use (in the money or how far out of the money calls?) or maybe a spread (married put? bullish debit spread, something else?) to initiate for trading breakouts when volatility is high.

Why breakouts?

I'm an experienced futures trader and my specialty is trading breakouts of classical chart patterns (think ascending & descending triangles, cup & handle patterns, flags, pennants, coils, etc). I mostly trade 2:1 risk to reward (3:1 or more when I find good asymetrical opportunities).

Why options?

I'm looking to expand. Expand into additional futures markets, stocks and sector ETF's, and trade them off daily and weekly charts over a multi-day or multi-week time period rather than limit myself to the intra-day trading I presently do on tick, range and 5 min charts.

I'm a disciplined trader so I know if I try and do this blindly, I'll get hammered into the ground. And (so far at least) the books and videos I've studied haven't been a lot of help on trading options on breakouts. So I thought I'd go out on a limb and see if anyone can point me in the right direction on the best way to structure these kinds of trades, so I can knock this out


To anticipate the market is to gamble. To be patient and react only when the market gives the signal is to speculate. - Jesse Lauriston Livermore

 

[drcruz]

If you are already a disciplined futures trader and comfortable picking direction, then trading long options (puts or calls) at around 80 delta should serve you fine (in other words deep ITM). What you want is to minimize the affect of the extrinsic value of the option. Far OTM options have a lot of theta decay - adds a layer of difficulty to directional trading

 

[darkcloudcover]

drcruz - thanks for the reply. If I go with deep ITM calls around 80 delta, will I run into issues with spread and/or lack of liquidity?

 

[drcruz]

It depends on what you trade. I only trade /ES so and I'm small so I don't see any liquidity issues. SPY and IWM are heavily traded and so are big named stocks like AAPL, GOOGL, NFLX, AMZN.

 

[drcruz]

I saw your post on ET and there's one answer I disagree with. The recommendation of OTM positions is not a good one. If you look at this pic the option decays at ~10 cents/day, when compared to the price of the option that turns out to be a loss of value of ~2%/day. This is a 10 delta call. EDIT: I drew the circle in the wrong spot

 

[drcruz]

The 80 delta call loses ~0.2% per day; cost = $142, theta = 0.25 cents / day. Both calls are at 44 Days to Expiration (AKA - DTE)

 

[drcruz]

He's right about the gamma though. If you have an OTM position "and you are correct" the value of the option explodes. BUT how confident are you at picking direction? My under standing is trend trading has a win rate of ~30 to 40% and if you are good at short term swing trading then may be OTM options are a good idea. For any length of time though you are fighting theta

 

[darkcloudcover]

good points drcruz. I've been hesitant to go OTM because time decay is so significant. Perhaps worth exploring since my win rate is higher but guess i gotta think how far OTM to go, if I were to go this route

Thanks for taking the time to post those along with the screenshots.

View attachment 278619
I saw your post on ET and there's one answer I disagree with. The recommendation of OTM positions is not a good one. If you look at this pic the option decays at ~10 cents/day, when compared to the price of the option that turns out to be a loss of value of ~2%/day. This is a 10 delta call. EDIT: I drew the circle in the wrong spot

 

[Chad Seven]

Apologies for crashing your thread, it caught my attention as I also trade breakouts, I also think I am good at picking direction and I also am interested in options.

The challenge that I have is that while I can pick the direction more often than not, I don't know exactly when the price will move in my direction which will result in many an option expiring worthless prior to the anticipated move occurring.

Would this impact your trading style?

 

[drcruz]

Apologies for crashing your thread, it caught my attention as I also trade breakouts, I also think I am good at picking direction and I also am interested in options.

The challenge that I have is that while I can pick the direction more often than not, I don't know exactly when the price will move in my direction which will result in many an option expiring worthless prior to the anticipated move occurring.

Would this impact your trading style?

This does not impact "my" style because I usually Sell options. For example if I were to see a breakout to the upside, then I would be comfortable selling an OTM vertical put credit spread or OTM broken winged put butterfly. So even if the market chops around prior to continuing w/ the trend I am taking advantage of theta (time) decay

 

[Chad Seven]

This does not impact "my" style because I usually Sell options. For example if I were to see a breakout to the upside, then I would be comfortable selling an OTM vertical put credit spread or OTM broken winged put butterfly. So even if the market chops around prior to continuing w/ the trend I am taking advantage of theta (time) decay

Thanks for the response.

Would you mind reviewing this idea a had for managing risk on my journal. Does what I am proposing makes sense? https://www.trade2win.com/threads/intraday-breakouts-targets.237392/post-3145338

 

[drcruz]

Thanks for the response.

Would you mind reviewing this idea a had for managing risk on my journal. Does what I am proposing makes sense? https://www.trade2win.com/threads/intraday-breakouts-targets.237392/post-3145338

I actually do not trend trade, but I try to take advantage of a trend that is there. So "for me" my position in your example would be a Put Credit Spread 0.5 standard deviation (about 25 to 30 delta) out of the money (OTM). I would enter the trade when there's a close above 3277 AND any following day that pierces the high of the green candle. Psychologically this helps because with options selling you have about a 70% chance of being write, BUT the adage, "pennies in front of a steam roller" applies . I do not trade pull backs because I am not comfortable picking direction I try to guess the markets current direction and, like a surfer, try to ride it's wave. I like Peter Brandt (this seems to be his style), but even he says pattern breakouts are only 30% to 40% correct and I accept those statistics

The Protective Put series from Tastytrade shows that using puts as hedges is a tough way to make money (see video below). So "I personally" do not buy puts for hedging. I trade mostly OTM Broken Wing Butterflies (BWBs) in only the /ES and I focus on price action. My strategy is neutral / bullish so if the market "looks" like it may start trending down I close the position (this saved me in the 2020 Coronavirus Bear Market). WARNING - I am still trying to nail down my final set of trading rules and have been working on them for about a year (I am freaking close though).

Protective Puts: Part 1

Does it make sense to buy puts as portfolio protection? tastytrade investigates.

www.tastytrade.com

 

[Chad Seven]

I actually do not trend trade, but I try to take advantage of a trend that is there. So "for me" my position in your example would be a Put Credit Spread 0.5 standard deviation (about 25 to 30 delta) out of the money (OTM). I would enter the trade when there's a close above 3277 AND any following day that pierces the high of the green candle. Psychologically this helps because with options selling you have about a 70% chance of being write, BUT the adage, "pennies in front of a steam roller" applies . I do not trade pull backs because I am not comfortable picking direction I try to guess the markets current direction and, like a surfer, try to ride it's wave. I like Peter Brandt (this seems to be his style), but even he says pattern breakouts are only 30% to 40% correct and I accept those statistics

The Protective Put series from Tastytrade shows that using puts as hedges is a tough way to make money (see video below). So "I personally" do not buy puts for hedging. I trade mostly OTM Broken Wing Butterflies (BWBs) in only the /ES and I focus on price action. My strategy is neutral / bullish so if the market "looks" like it may start trending down I close the position (this saved me in the 2020 Coronavirus Bear Market). WARNING - I am still trying to nail down my final set of trading rules and have been working on them for about a year (I am freaking close though).

Protective Puts: Part 1

Does it make sense to buy puts as portfolio protection? tastytrade investigates.

www.tastytrade.com

Useful info, lots to think about. Thanks for the TastyTrade link, very helpful.