Trading Options on Bullish Patterns

by Ray Frazier

Let’s discuss the use of options with trendlines.  You will be determining the option type to use for the specified trendline or chart pattern, the buy point and an explanation of what to expect from each chart pattern.

The first example is an ascending triangle, shown on the chart below, which is considered to be a bullish pattern.  This formation is formed by a horizontal resistance line and an upward trending support line.  To play this pattern with an option you would expect the stock to go up in price.  First, since the pattern is considered to be bullish, you need to determine the option that you will play.  To determine the option, you will need a buy point.  Now on this particular chart the buy point would be as the stock crosses the resistance line, which is at 130.  To give the stock some room, my buy point would be 131 to 132.

Now that we have a buy point, we can determine the option strike price and the option expiration.  You will note that the stock price crosses the resistance line on March 9th.  Since the date is near option expiration for March, we know that the options expiration that we choose should be April or any future expiration month.  So now we have the buy point of 131 in the expiration month of April or any future expiration month.

This example is an actual trade that I made.  Using the chart and the information that we have been able to determine, I bought the April 135 call option.  Since the stock crosses the resistance near the end of the March expiration month, I decided to go with the April expiration month.  Since the resistance line was at 130 and I have determined that I would buy when the stock crossed 131, and since the chart pattern is considered to be bullish, I decided on the 135 strike price and bought a call option.  Now we have an April 135 call contract.

This particular trade was placed on March 22nd, and sold on March 29th.  The cost of each option at the time I bought it was $12.  Since the minimum you can purchase is one options contract and one contract equals 100 options, the price paid was $1,200.  At the time I sold the contract, the bid price of the contract was $29.50 per option… $2,950.  My profit was $2,950 – $1,200 = $1,750 per contract.  That is a 146% gain on my original investment!

The following example shows a bullish channel pattern.  The resistance line has been drawn in, which contains the upper-most stock price and the support line contains the lower-most stock price.  Since this is considered to be a bullish pattern, we need to determine how to play an option based on the pattern.

First and foremost we would need to determine the buy point.  In this example the resistance line was at 190.  At the time I was watching the stock, my buy point was 192.  However, the actual day the stock crossed resistance, the stock gapped up some 20 odd points at the open due to an outstanding earnings report the night before.  This was during a time when many computer companies were warning of shortfalls in earnings, and due to the gap up on the open I quickly decided to change to the best possible price I could get.  At the same time, I quickly determined that since the stock crossed its resistance line near the end of April, the expiration month would have to be May.

With the information I had gleaned from the charts and the actual price action of the stock on the day that it crossed resistance, I decided to buy the May 195 call contract on April 23^rd.  The price per contract was $675… $6.75 per option.  On April 28^th, I sold the contract for $1,125… $11.25 per option.  My profit was $1,125 – $675 = $450, a gain of 67% on my original investment in three trading days. 

Last, I will show you a chart of Realnetworks, Inc.  This example will show you that you do not have to have a chart pattern to play options on a stock for the short term.  You’ll see that I have drawn in a resistance line only.

This is another actual trade I made.  First you see that the resistance line is at $75.  So my buy point would have to be as the stock crossed the resistance line.  I bought as the stock crossed 76 in order to allow some room for the stock.  The stock crossed its resistance line on June 30, which put us in a July expiration month at the minimum.  As the stock crossed 76 I put in an order to buy a July 75 call.  The price of the option was $7 per option, or $700 per contract.  I sold the option on July 6 at a bid price of $20.50 per option, or $2,050 per contract.  My profit (excluding commissions) was $2,050 – $700 = $1,350 per contract, a 193% gain on my original investment!