Use Price Action Trading Strategies To Trade Futures Options

Occasionally I will get an email asking if a trader can use price action trading strategies to trade futures options.  The answer is obviously yes, as you can definitely use price action trading strategies to trade futures options.  In fact, you can use price action trading strategies to chart and trade any market, and it works on any time frame as well, so no matter what chart size you prefer, you can still learn to read that price chart like a trading professional.

Futures Options And Price Action Trading

Futures Options And Price Action Trading

What you have to understand is that once you learn to use price action techniques to read a price chart, you will instantly learn to have a much better understanding of what your chart is telling you and where prices are likely to go in the future.  Reading a price chart is a skill, just like learning to track big game or learning how to fly an airplane.  The more time you spend doing it and practicing it, the more you learn and the better you will get at it over time.

Once you learn to read the price action movements on your trading chart, your job is then to predict where prices have the highest likelihood of going in the near future, so how you enter or what format you use to position yourself to profit from on that price movement is irrelevant.  You could enter with futures contracts or futures options and profit or lose from either one, so hopefully that makes sense to you now.  The bottom line is that you must be able to predict where prices are going in the near future and then you can position yourself with the instrument of your choice in order to profit from that movement, assuming of course that you were correct in where you determined prices would be going in the long run.

While there are some additional rules and regulations around trading with futures options, we are going to assume that you already have a basic understanding of futures options when discussing the rest of this information and article.  In some cases, trading options may actually have some benefits over trading futures, but there will be some short comings just as well.  The main benefit of options over straight futures contracts is the fact that your timing does not have to be exact when using options.  When you enter with a futures contract, you may actually get the direction right, but be early to the game so you still lose money on the trade due to a lack of staying power.

If you enter a trade early with a futures contract, prices could continue to move against you short term costing you a large sum of money.  With options, the danger of short term movements going against you are not nearly as costly, so you potentially have more staying power and you do not have to be nearly as good with your timing.  You just need to be close with your timing, and getting the near term direction correct is the most important aspect of the trade.  With straight futures, you must get the direction right, but your timing must be spot on as well, because the leverage is much higher and every tick in the wrong direction could be extremely costly to you.

Now, having said all of the above, I am going to throw you an unexpected curve ball.  All of the above on using futures options was based on “buying” options.  Now we are going to discuss what many  consider to be a completely taboo subject, and that is are of “selling” futures options.  Selling options is often considered the worst way to trade futures, because of the unlimited losses that can occur.  When you buy options, you can never lose more than what you paid for that option.  However, when you sell options, your income in limited, but it is similar to trading full futures contracts, and your losses are not limited, but can rather be unlimited.

Selling options is supposedly preserved for professional traders only, but here is something to consider:  90% of all options expire worthless!  That is correct, 90% of all options expire worthless and out of the money, so what does that tell you about the profits that those professional traders that sell options are making?  If it’s so hard to make money “buying” options, and 90% of all options “sold” actually make money, then why is “selling” options such a bad way to go?  If you learn to read a price chart properly and you can use price action strategies to learn to read a chart accurately, then you can be even better at predicting where prices won’t go than you will be at predicting where prices will go, and that’s why we are suggesting that you consider selling options over buying them!

Here is an interesting pieces we found at that was written by Angad Guglani.  Here is what Angad had to say about “selling” options.

One of the more conservative options strategies I utilize has its roots in the efficient market hypothesis. This hypothesis states that all available information is currently priced into the stocks. According to the hypothesis, it is difficult to beat the market consistently, because the only way to do so is to both predict the future news and how this will be priced into the stock. The validity of efficient market hypothesis is the topic of much debate, but it is a good place to start for the purposes of this article. In accordance with efficient market hypothesis, each stock is just as likely to outperform or underperform the market. If no substantial news or information is realized, each stock will perform just how the general market does. Currently the S&P 500 (SPY) trades at the price to earnings of 13.22 based on forecasted earnings of $102.40. This implies that the index should yield 7.56%. Since 5.56% (7.56% – Current yield of 2.00%) of these earnings are held in company reserves, the value of the company should appreciate by 5.56%. The last piece of the equation is the rate of inflation, which will effect the hard assets and future earnings of the company. The current inflation rate is about 2.5%. This implies that the value of the index will rise by approximately 8%

The chances of the market gaining exactly 8% are quite slim, even though this is what is priced in. Every day new news and information is constantly being priced in, causing the prices of stocks to fluctuate. For example, positive news out of Europe could move the markets up 10% in the matter of days, but the fact remains that negative news developments are just as likely to move the market down as positive developments are to move the market up.

The Efficient Market Option Strategy: This strategy is for investors who are risk averse and not looking for wild market swings. This strategy relies on the assumption that over the long run, the market should yield about the expected return. One can implement this strategy by selling call options at a strike price that is indicated by the market expected rate of return. As it stands to today, this would be a yearly rate of 8%. If I own a stock priced today at $100 a share, I would sell strike $108 calls.  You can read the entire original article here.

While the article is discussing stocks, the strategy works the same in futures, and the strategy is interchangeable, so don’t get hung up on the fact that his wording is around stocks.  Also, if you are not familiar with options, this strategy will seem very complicated, when in fact, it is relatively easy.  First you need a basic understanding of how options work, but with a little reading and research, that is not too difficult.  All you really need to understand is the following:

  • Selling options actually pays you up front when you sell it.
  • The idea with our strategy is to determine where prices are going using price action strategies, and then to sell an option far out of the money in the other direction.
  • Here is a link to some expert information on selling futures options in case you would like to learn the ins and outs of this exciting technique.

As an example.  Let’s say the ES is trading at 1,000 and you have determined that prices are headed higher and will likely reach 1,100 in the next couple of months.  You will then find a put option that is as far out of the money (below 1,000) as possible that will yield you your desired profit (let’s assume $500.00 is our profit target).  After doing the research, you determine that you can sell a 900 strike options that expires in 30 days for $525.00, so you sell it and place the $525.00 into your trading account.  As long as that option expires in 30 days and prices are still above 900, then you keep 100% of your profits.  The only way you can lose money is if prices are below 900 when the option expires in 90 days.

Yes, the price of the option may fluctuate up and down over the next 30 days as prices move up or down, but if prices are moving in your predicted direction, you can probably buy your option back before it even expires for half or less and then find another new trade, pocketing the quick profit.  The strategy is best if you just let the option expire, but you can do it both ways if you so choose.

Hopefully you can see the benefit of this strategy if you are really good at reading the price action and picking the direction of prices.  Also, make sure you read all of the original article written by Angad so that you have a solid understanding of how selling options increases your odds of being right more times than not.  After all, remember that 90% of all options expire out of the money and worthless.   That puts the odds on your side to begin with just because you are selling an option  that is far out of the money.  If the trend is currently moving in your favor too, then you put additional odds on your side.

We hope you can now see how you can use price action trading strategies to trade futures options and how the strategy can benefit you.  If you have the desire and knowledge, you can study our strategy of selling options and really put the odds of profit on your side.  What we have given you in this article are only the basics, so do your homework before actually utilizing this strategy, as selling options is not something you want to do on a whim and a prayer.

Below is a YouTube video that gives you additional information on selling options for premium income.