Posted in
Big Picture
By: Tom Gentile
on October 11th, 2024
A Top-Down Approach to Finding Securities for Options Trading Once the Presidential Election Results Are In
When it comes to picking your choice for President you may already have that nailed down. Some of you may already have voted by now. But when it comes to finding or picking a stock or ETF to trade options on it may not be so easy to pick.
This article is going to give you some ideas on how to do so and the best way I know to go about my approach in executing Step #1 in my 3-Step Options Trading Process – Finding an Opportunity is to take a Top-Down approach.
What Do I Mean by a Top-Down Approach?
A Top-Down approach when it comes to finding a stock or an ETF in a deemed position to make a directional move higher or lower is where one starts looking at the overall equities market. They then start drilling down on a more specific grouping or sector of stocks like an Exchange Traded Fund (ETF) and from there start looking at the stocks within that ETF to find the one or two stocks they feel most assured will make a directional move higher or lower.
The Top-Down approach starts with the broader more general view of the overall markets and works towards getting down to the more specific choice. The Bottom-Up approach is the opposite in that it starts with looking at a specific stock or group of stocks and expands the view to a wider range of factors.
For the Top-Down approach I tend to go along this path.
Analyze the Overall Markets (Dow Jones Industrial Average, NASDAQ, and the S&P 500)
Analyze Sector ETF’s (e.g., SPY, QQQ, XLF, JETS, SMH, USO, etc.)
Analyze Stocks Within Those Sectors (MSFT, AMZN, BAC, DAL, XOM, etc.)
I do Technical Analysis more than Fundamental Analysis when Options Trading
I mostly rely on a technical charting view when it comes to trading options. I am usually looking for a time frame for the underlying security for an option to make a move within 20-30 days upwards of 60 days max to make its move.
Technical patterns are visible, and I can see repeatable patterns in shorter time frames, and I want to use the leverage of options with those short-term patterns to capitalize on.
Fundamentals have their place, and I use them more when I am considering a long-term investment not a shorter-term option trade.
The one fundamental piece of information that WILL come into play most often when I am trading options is earnings. I tend to steer clear of or clear out of any options I may have on with a company that is due to report their earnings. It gets too risky as to what the stock price action will be whether the report is good or bad.
Looking for Tradable Patterns
Start with the Big Three: Dow Jones Industrial Average, NASDAQ and S&P 500
I start out going over the technical picture of the big three indexes. I look at 30-60 charts, outwards of up 120-day charts and will expand out to a year-to-date chart time frame view.
I am looking for visible repeatable patterns.
SUPPORT and RESISTANCE: I like it when I find a security that trades consistently between a support and a resistance price. I consider going long calls off support and trade it to resistance and long puts if it is setting up the other way around (trading long puts off resistance and look to trade it to support).
Old Resistance becomes New Support and Vice Versa
This is a pattern that occurs when a security breaks out of Support or Resistance. The security will make a move past either support or resistance and then come back and test that price are, but rather than fail the breakout that old price for resistance may become the new support area. I would consider a bullish option strategy like going long calls in that instance. I would consider a bearish options strategy if the opposite happens.
I can go on and on with a great many more technical patterns and setups, but that isn’t the point of this education. I may do a series of my favorite technical patterns setups in the future, but this will suffice for now.
The question one may be asking or should be asking is…
WHERE do I start to look to find a security with ANY pattern?
I already gave you the big three indexes.
Now start to break things down by what part of the market is seeing the mist buying or selling pressure.
Are the Financials going to benefit now or soon with the Fed cutting interest rates? Possibly.
Is the tensions in the Middle East going to continue? If they are that may help spur on higher prices in oil and energy. If things calm down maybe oil and energy stocks sell off to a degree.
Those are two example of things one can think about and try to assess in their mind and then go focus on the technical picture of those sectors and stocks in those sectors.
I am a visual learner, and I like to make my assessment on directional bias for any security with visuals as well.
Website one can use to do analysis of Exchange Traded Funds to ETF’s are:
1) Tom’s Option Tools: www.tomsoptiontools.com
Log in and go Stocks > Stock Analysis > Sectors
4) www.etf.com
Further Refine Your Stock Selection Search for Options Trades
Once you have found a website you like and find it easy to navigate for ETF’s and groups of stock information. Then you can further refine your search to stocks within those ETF’s.
Key things I make a note of are which stocks have the largest or highest weighting in the ETF. This way I know if I am trading the deemed industry leader and one that has a better chance of having more liquidity of trading.
If the stock has a large trading volume (liquidity) the options will have a higher likelihood of trading higher volume. It is the large or large amount of liquidity (Volume and Open Interest) that will lend the options to having tighter bid/ask spreads and if you know options trading the tighter the bid/ask spread of the options the better chance one has of not only profitability, but profitability quicker than options with very wide option spreads.
An example of weighting is from www.sectorspdrs.com below.
Building a List of Stocks to Watch
At this point one can now build a list of securities that they want to make their ‘watch list.’ It can change over time, but at least build one to start with. Stocks with large trading volume, leader in their industry, and have favorable or not so favorable news – depending on which direction you see it needs to be trades.
Run Your Scans
From there, in my tools at least, www.tomsoptiontools.com one can now run that list in a variety of different scans based on any number of technical criteria one favors.
They can run a Moving Average Crossover scan. They can run Earnings scans. Money Calendar is the one my students /subscribers favor a great deal.
Congratulations!
You’ve Learned a New Top-Down Approach to Finding a Security to Consider for Options Trading
You now possess an idea of a Top-Down Approach to finding a security, ETF or stock, to consider your options trades on. When you do your analysis and wish to move forward with a trade I encourage you to work with your broker for the suitability of it in your portfolio.
To Your Best Success!
To your success,
— Tom Gentile
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Disclaimers
Stock and options trading has large potential rewards, but also large potential risk.
You must be aware of the risks and be willing to accept them in order to invest in the stock and options market. Do not trade with money you cannot afford to lose.
This is neither an offer to buy/sell/ or recommend a particular stock or option.
Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been actually executed, the results may have under or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with hindsight.
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