Yesterday, we looked at a Daily Price Chart of the iShares U.S. Real Estate ETF, noting that the ETF’s OBV line is sloping down, validating the recent bearish trend.
For today’s Trade of the Day we will be looking at an On Balance Volume chart for Toyota Motor Corp. stock symbol: TM.
Before breaking down TM’s OBV chart let’s first review which products and services are offered by the company.
Toyota Motor Corporation designs, manufactures, assembles, and sells passenger vehicles, minivans and commercial vehicles, and related parts and accessories. It operates in Automotive, Financial Services, and All Other segments. The company offers hybrid cars under the Prius name, fuel cell vehicles under the MIRAI name; and conventional engine vehicles, including subcompact and compact cars under the Corolla and Raize names.
Confirming a Price Downtrend with OBV
The TM daily price chart below shows that TM is in a price downtrend as the current price is below the price TM traded at five months ago (circled). The On Balance Volume chart is below the daily chart.
On Balance Volume measures volume flow with a single Easy-to-Read Line. Volume flow precedes price movement and helps sustain the price downtrend. When a stock closes up, volume is added to the line. When a stock closes down, volume is subtracted from the line. A cumulative total of these additions and subtractions form the OBV line.
On Balance Volume Indicator
● When Close is Up, Volume is Added
● When Close is Down, Volume is Subtracted
● A Cumulative Total of Additions and Subtractions form the OBV Line
Volume flow precedes price and is the key to measuring the validity and sustainability of a price trend.
We can see from the OBV chart below that the On Balance Volume line for TM is sloping down. A down-sloping line indicates that the volume is heavier on down days and selling pressure is exceeding buying pressure. Selling pressure must continue to exceed buying pressure in order to sustain a price downtrend. So, On Balance Volume is a simple indicator to use that confirms the price downtrend and its sustainability.
The numerical value of the On Balance Volume line is not important. We simply want to see a down-sloping line to confirm a price downtrend.
Confirmed ‘Sell’ Signal for TM
Since TM’s OBV line is sloping down, the most likely future price movement for TM is down, making TM a good candidate for a put option purchase.
Let’s use the Hughes Optioneering calculator to look at the potential returns for a TM put option purchase.
The Put Option Calculator will calculate the profit/loss potential for a put option trade based on the price change of the underlying stock/ETF at option expiration in this example from a flat TM price to a 12.5% decrease.
The Optioneering Team uses the 1% Rule to select an option strike price with a higher percentage of winning trades. In the following TM option example, we used the 1% Rule to select the TM option strike price but out of fairness to our paid option service subscribers we don’t list the strike price used in the profit/loss calculation.
Trade with Higher Accuracy
When you use the 1% Rule to select a TM in-the-money option strike price, TM stock only has to decrease 1% for the option to breakeven and start profiting! Remember, if you purchase an at-the-money or out-of-the-money put option and the underlying stock closes flat at option expiration it will result in a 100% loss for your option trade! In this example, if TM stock is flat at 135.85 at option expiration, it will only result in a 0.7% loss for the TM option compared to a 100% loss for an at-the-money or out-of-the-money put option.
Using the 1% Rule to select an option strike price can result in a higher percentage of winning trades compared to at-the-money or out-of-the-money put options. This higher accuracy can give you the discipline needed to become a successful option trader and can help avoid 100% losses when trading options.
The goal of this example is to demonstrate the powerful profit potential available from trading options compared to stocks.
The prices and returns represented below were calculated based on the current stock and option pricing for TM on 10/10/2022 before commissions.
When you purchase a put option, there is virtually no limit on the profit potential of the put if the underlying stock continues to decline in price.
For this specific put option, the calculator analysis below reveals if TM stock decreases 5.0% at option expiration to 129.06 (circled), the put option would make 47.0% before commission.
If TM stock decreases 10.0% at option expiration to 122.27 (circled), the put option would make 94.6% before commission and greatly outperform the stock*.
The leverage provided by put options allows you to maximize potential returns on bearish stocks.
The Hughes Optioneering Team is here to help you identify profit opportunities just like this one.
Interested in accessing the Optioneering Calculators? Join one of Chuck‘s Trading Services for unlimited access! The Optioneering Team has option calculators for six different option strategies that allow you to calculate the profit potential for an option trade before you take the trade.
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Wishing You the Best in Investing Success,
Editor, Trade of the Day
Have any questions? Email us at email@example.com
*Trading incurs risk and some people lose money trading.