Options Trading For Beginners: Market Timing

Market timing is everything in investing, but when you have an egg timer running constantly it makes your opportunity for success that much more difficult.  That is what we face as option traders.  Now, as option sellers we have the luxury of time being on our side, preferring to let options decay and take in the premium before expiration.  Premium sellers are often content with a stock moving sideways.  On the other hand, option buyers need stocks to with robust action up or down.  We use the charts and analyze the technicals carefully to find the ones with established patterns which can move within the time frame considered.

For a buyer of options (puts or calls), we must be aware of timing mechanisms, the current environment and chart analytics in order for us to have a chance with a directional bet.  The charts are a great place to start, but if there is risk in the markets and conditions are not favorable then we may have to pass on a trade idea.  Market signals are important to follow from a macro viewpoint, and they may keep us out of harm’s way.  For instance, is it prudent to go long SPY index calls after a massive run higher and overbought signals are apparent?  We look at put/call ratio trends, breadth indicators, polls and mutual fund money flows along with the VIX to give us the best reads on sentiment.  Of course, price and volume action are the most important indicators.

Lately, we have seen some secondary market signals flash buy alerts.  The breadth indicators we follow clocked in with a confirmed buy signal, while the VIX remains low (stocks can rally while the volatility index is lower, but when it trends up that signals trouble).  Put/call ratios has trended down, and while this may seem cautious they are coming down from lower levels.  Sentiment polls, which are contrarian in nature have far too many in the bear camp.  So, these all line up for potential buy signal, yet the price of markets (SPX 500, Dow Industrials and R2K) have not confirmed with a breakout.

So, what to do?  Do we take the secondary signals and risk a potential rollover and buy the market, or do we wait for price to confirm?  I prefer to err on the side of caution, waiting for the primary signal of price action to side with other market signals.  This is the truest and best signal we have – price action confirmation.  However, we have to be aware of other signals that may be flashing a sign – getting us ready to make a move.