How to Use Technical Analysis for Option Trading (Simple techniques)

Today I will share with you 3 simple Technical Analysis tools I use to put massive cash flow in
my pocket every month & to improve the odds of winning my option trades. By the end of this
post, you will clearly understand these 3 simple technical analysis tools so you can begin using
them to put cash in your pocket, starting today!

First, why should you use technical analysis? Technical analysis can help turn a blank
screen when it comes to stock & option trading into a screen filled with information to help
you make better trading decisions. I’m excited to share with you the simple technical
analysis tools I use to be a better, more profitable option and stock trader!

Over the past few posts I have been talking about a position I have been trading in Kraft
Heinz, ticker symbol KHC. I started out by selling the 27 ½ puts in January and have been
rolling those puts ever since. A couple weeks ago, I went ahead and sold a full short put
position in this stock, and technical analysis is the reason why.

Before we dive into this position, I first want to make sure you know that I only trade
stocks that I feel good about fundamentally. I like Kraft Heinz fundamentally. It is a
company that has been really beaten down and I have been waiting to put on a full short
Put position until technical analysis gave me the green light. A few weeks ago, that
happened.

Now you are probably reading this post at least a week or 2 after I wrote it. So just
understand that you will have the benefit of hindsight on me here. But I also don’t trade for
the short term. Yes, I like to trade options monthly, but my decisions are based on the fact
that when I enter an option trade on a stock, I expect to be in that stock, in one form or
another forever, or until the fundamentals change on the company.

So here we go, what technical analysis tools prompted me to move into a full position on
Kraft Heinz? The first one is volume. Volume is defined as the number of shares traded in
a stock for a specific period of time.

How can we use volume to be on the right side of trades? Let’s look at the chart of Kraft
Heinz and see.
First here, look at the daily chart of Kraft Heinz. Notice there on the bottom right where I
have circled the daily volume bars, that over the past few weeks volume has increased as
the corresponding candlesticks or stock price moved higher. The green volume bars are up
days and the red are down days.

Notice 2 things here:

1. First, on the green up days, the average volume is higher than on the red down days.
When you see stronger or higher volume on up days, that’s a good indication that there
is more interest in buying this stock than selling it.
2. Second, notice that the volume has been dropping the past 5 days. This corresponds to,
if you look at the top at the candle sticks, or price action of the chart, the decrease in
volume is coupled with the stock price reaching a peak, and basically losing steam or
topping out. It reminds me of an ocean wave. You see it has hit that $35 mark & can’t
seem to push through it. As a matter of fact, the ability to push this stock higher seems
to be diminishing for now.
On the one hand, the stock seems bullish because there are more up/green volume days
then down/red volume days over the past few weeks and the number of shares traded on
those up days is greater than the number of shares traded on the down days. But now it
seems as though this wave might be running out of steam. It’s like the top of a literal ocean
wave. When the wave is highest, typically you know that pretty soon, it will crest, and the
wave will subside until the next wave begins. The same thing is happening here.

This tells us that this wave that pushed Kraft Heinz from around $31 per share to $35 per
share, seems to be running out of steam, and we can expect it to either drop some and
retest the previous high of the previous wave, which was around $33 ½ or maybe even
retest the green 50 moving average line, which we will get to in just a minute.
Let’s stay here on the Kraft Heinz daily chart and talk about the second technical analysis
tool I like to use, which is the actual candlesticks on the stock chart itself. What can the
candle sticks tell us?

They tell us that overall, this chart and Kraft Heinz is in an up-trending market on the daily
timeframe. How do we know that? Each progressive high and low part of the next wave is
higher than the previous high and low of the wave before it.
Notice here that the previous wave’s high was around $34, the current wave has now
topped out around $35. The previous wave’s low was around $28, the current wave’s low is
around $31. So, we are seeing higher, highs and higher lows. This tells us that Kraft Heinz is
in an uptrend on the daily chart.
Contrast its current higher highs and lows with the time period between January and April.
Here we see it was making lower highs & lower lows. That confirmed that it was in a down
trend on the daily chart.
Also notice that the red, down day’s volumes were A LOT higher volume then the green, up
day’s volume. Again, another indication that it was in a down trend.

The 3 technical analysis tool I like to use before we get to a bonus tool is moving
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averages. I like to use the 50 and 200 period moving average on all my time frame charts.
Some people like to use the exponential moving averages, but I like things simple. As such I
use the simple moving average.

What is the simple moving average? The simple moving average is the average of a group of
prices, usually closing prices, plotted on the chart for each period. For example, on the 50-
day moving average, the simple moving average is the average stock price of the last 50
days.

The 200-day moving average is the average stock price of the last 200 days.
Put simply, if the 50 moving average is higher or above the 200 moving average, the stock
is in an uptrend for that time frame. If the 50 moving average is lower or below the 200
moving average, the stock is in a down trend.
Here on our chart, the green moving average line is the 50-day moving average and the red
line is the 200-day moving average. Notice how until the teal up arrow, Kraft Heinz was in
a down trend because the green 50 moving average was below the red 200 moving
average. BUT on June 16th, the green 50 moving average crossed over and above the red
200 moving average and at that time Kraft Heinz switched from being in a down or bear
trend to an up or bull trend on the daily chart.

By the way, if you’d like your charts to automatically put that crossover arrow on there for
you like the Teal up arrow on my chart, in Interactive Brokers, you can find it under
studies, and it’s called the MA Crossover. You should have something similar on your
trading platform.

Now notice what has happened around the moving averages. Moving averages tend to act
as magnets and trampolines! Notice how when Kraft Heinz was in a downtrend the 50 and
200 moving averages seem to pull the stock price back to them from time to time, but once
the stock price reached them, it tended to bounce off of them like a trampoline and push
them back down. Now that Kraft Heinz is in an uptrend, that 50 moving average and to
some extent the 200 moving average again seem to pull the stock back to them from time to
time, but once the stock price reaches that moving average, it tends to bounce off of it.

Right now, the 50 moving average seems to be a nice place where the stock might find
support and bounce higher. As such I would expect Kraft Heinz to try to come back down
and possibly get as low as $32 per share, or where the 50 moving average is currently at. It
may not, but odds are, the “magnetic pull” of that 50 moving average will try to pull the
stock back to it before the stock tries to bounce off of that trend line again to try to begin a
new wave up.

That’s why that 50 moving average is where I have sold some puts as you can see here on
the screen.

Using all the technical analysis tools we have discussed here, I decided to do a full position
in Kraft Heinz by selling a full complement of short puts. I feel so strongly about this trade
and the stocks ability to move higher as I discussed in previous post, that I actually sold the
$35 Strike puts as you can see on the screen here.

Ideally it would be awesome if the stock would drop down to the 50 moving average and
then we sell puts just below that moving average. But as long as you know that the stock
price has the potential to come back to that 50-moving average, then selling puts anywhere
in that general vicinity could prove to be profitable. Keep in mind that although these
technical analysis tools are helpful, they cannot guarantee when a stock will change trends
and direction. At some point this current uptrend on the daily chart will change back into a
downtrend. We don’t know when. But technical analysis definitely helps in putting the odds
in your favor as an option trader.

At the beginning of this post I told you that I would give you my favorite bonus technical
analysis tool that will make it quick and easy to make trading decisions. That tool is
channels. Let me show you how they make trading decisions so quick and easy.

I’m going switch from my Interactive Brokers charts to my E*Trade charts because I really
like how channels look on E*Trade. Take a look at this chart of Kraft Heinz.
It is not very easy to quickly make any decision on this chart is it? Now watch what
happens when I add in the channel tool.
WOW!

Using this technique, I’m able to quickly run through the approximately 160 stocks I track
weekly to pick out the ones that are prime to sell put options on or buy outright in my
retirement account. Now looking at this channel tool, it’s so easy to see when the stock
price is at a level where it’s a good time to sell puts or calls, buy the stock at or just wait to
do anything.

The channel also really quickly helps you see when a stock has changed trend direction. In
this case, it was really quick and easy for me to see at the down arrow, that Kraft Heinz had
switched from a down trend and was trying to break out into a new up trending channel.
Now you might be saying, but Randy you’ve been doing this for a long time, it’s easy for you
to draw those channel lines. Let me show you how easy it is.
I like to draw my trend and channel lines on the weekly charts. Then switch back to the
daily charts. But you can draw them on any time frame you like. One reason I like E*TRADE
is that once I put my channel in place, it doesn’t matter what time frame chart I swap to, the
channel stays exactly where it was. Personally, I look at multiple time frames when making
trading decisions. That is a subject I will talk about in a future post but for now just make
sure to connect the two most recent low points of the two most recent waves for the
bottom of the trend line and the 2 most dominate or high points of the 2 most recent waves
for the top of the channel. This gives you a nice-looking channel that you can use to make
trading decisions.
In an up-trending situation, ideally, you’d like to sell puts when the stock is at the bottom of
the channel (where I have the black circles) and if you’re using a covered call strategy, sell
calls when the stock is at the top of the channel, or where I have the red circles. This will
massively put the odds in your favor for 2 reasons:

1. First, since you’ll be selling put options at the bottom of channels, you will be selling
when volatility is higher as compared to selling puts when the stock is at the top or
middle of a channel when volatility is lower because you will be selling puts after
the stock has recently dropped in price thus most likely, to have increased in
volatility. This will put more cash and higher premiums into your pocket.
2. The second reason is that if the stock ends up getting Put into your account, not only
are you buying it after a good drop in price, so at a better price, but you’ve already
been paid that higher put premium because you sold the puts at a time when
volatility was higher. So, you’d be buying at a lower price and getting paid more for
selling those Put options. It’s a total Win-Win! You’re winning 2 times, before you
even have to think about the stock getting put into your account.

The reverse can be done if you’re using a covered call strategy. Wait to sell call options until
the stock is in the upper part of the channel or in the red circles. You will get more for those
call option premiums because buyers are excited after seeing the stock go up so much so
they will pay more for those call options you are selling.
I typically try to do exactly what I described above. Every week I’m looking for new stocks
that are in the lower part of their channels, the black circle area, to swap out for other
stocks that have pretty much lost all their time value premium. By using these technical
analysis tools, you can have a continual supply of good companies to sell put and call
options on that will keep your pockets full of cash.

As a note, sometimes I will sell put options when a stock is not at the bottom of the channel
or call options when a stock is not at the top of channel because I believe it may take too
long for the stock to get there, and I like to keep my cash rolling in. But I will only do this if I
get at bare minimum of 15% cash on cash annualized return on the option. Typically, it’s
higher than 15% but that’s the bare minimum I want to accept.

In my next post I will do a recap of all the cash flow I received in the month of July by
selling call and put options as well as collecting some dividends.

Until next time, HAPPY INVESTING, and we’ll see you again soon!