Income Trades and The Markets

US Dollar Income Trades

Incomes Trades

USX-US Steel Group, Inc. (X) has been a lucrative long stock position since it broke out in late 2017, trending from December through January. In addition, price action presented income opportunities as this flag pattern developed over the past three weeks. Friday made the 5th income trade in a row, that made money for members.

X Income trade

The Strategy 

Each morning we look for price action to produce an intraday ABCD pattern.

ABCD-Pattern Income Trades

It is this pattern and consolidation that continues to provide an opportunity to sell covered calls. Once we recognize the pattern, we sell covered calls at the high or “A” pivot, then we look for the “B” pivot or an intraday low to buy back those covered calls. Occasionally we have to wait for the low in the next training session. We repeat that process until the pattern breaks.

When do we know the pattern has broken? Let’s review a few basic concepts.

Income Trades – Implied Volatility

The key to selling option premium is implied volatility. When implied volatility is very high relative to a 12-month historical mean we look to sell premium. When implied volatility is low we look to buy options and trade directionally. This is important.

It is also prudent to pay attention to whether the stock is trending or basing. We are looking for a stock that is basing to sell premium when implied volatility is high. Currently, USX-US Steel is presenting both consolidation and high implied volatility.

X Income Trades

When a stock is trending, like X illustrates in December and January, there’s a higher probability that we will need to roll calls up as the stock continues to move higher. Therefore, we would not sell covered calls during this period.

Income Trades – Not When The Stock is Trending

Atlassian Corp. (TEAM), a current watchlist candidate illustrates this concept. Ask yourself, is it trending or is it basing?

If all the fundamental criteria for our potential candidate meets our “checklist” we then go to the technicals. Since TEAM is an IBD50 listed company, we know the fundamentals are excellent.

We identified a base during January and February, so we added the stock to our watchlist and took a trade on Monday. Prior to the breakout, we wanted to determine if it was trending or basing. We also wanted to consider how long the stock trended after the prior breakout in late September, early October.

This “lookback” gives us a feel for what sort of trend to anticipate after the next base breakout.

We assume TEAM will continue along its current path until something changes to force the stock to start basing again. For now, we assume the stock will continue to trend. We do not want to sell covered calls now.

TEAM Income Trades

Income Trades – IV Rank

Although we wouldn’t want to sell covered calls when our position is trending, there are still potential income opportunities with this candidate. Since IV Rank is above 54%, we could initiate bull put “credit” spread.

TEAM IV Rank Income Trades

This is a technique that applies similar principles to being long a stock. We use options instead. Since we are bullish, we sell a close to the money put and buy an out of the money put one strike lower for protection. In this type of trade, we receive a credit. We receive income.

In the unlikely event that the stock pulls back, we would buy back the short put and keep the put that we bought for protection. Then we might let the directional trade (long put) continue to produce a profit. Alternatively, we could close the trade for a small loss or go flat as the put we bought for protection begins to increase in value, offsetting the loss on the short put.

Most likely, TEAM will continue to trend, so the probability of a loss with a bull put spread is less than 50/50.

Income Trades – The Keys to Success

Answer these questions before taking an income trade. This is also something new traders should do before taking any directional trade, especially if she is thinking of buying options.

  • Is the market index trending or basing?
  • Is the stock in question trending or basing?
  • Is Implied Volatility high or low?
  • What is the IV Rank or IV Percentile?

Is the market index trending or basing?

The indices have been trending for the past week (60-minute charts), since the Friday reversal. NYHL, one measure of “trending or basing” that we use every day shows more stocks are making new highs versus new lows.

NYHL Income Trades

We feel comfortable when we see a trend in the moving average. In this case, the trend or moving average reversed after the February 9 low. Histogram bars are growing in height. Note this also got us out of the markets prior to the big drop in February. The trend reversed and histogram began producing shorter bars “before” the selloff.

Is the stock in question trending or basing?

NTAP just broke out of a consolidation pattern (base) or descending channel. It was on the watchlist two weeks ago for this reason. The stock is trending now and will most likely break above the January pivot high at 64.06. Once it does, this will confirm the stock is trending higher. A pause at 52-week highs would present opportunities, as a flag or handle could develop. We would pass on covered calls, but we might consider a bull put spread for a credit if IV Rank is above 50%.

NTAP trending Income Trade

Is Implied Volatility high or low? 

NTAP has an implied volatility rank of 40%. Therefore, we could use directional options positions (ATM) or trade the common stock, but we would not enter a bull put spread or sell covered calls until this number is greater than 50%.

NTAP IV Rank Income Trades

In summary, even if you are uncomfortable with trading options, understanding whether your candidate is basing or trending will make a huge difference in your profitability. If you are trading options, understanding implied volatility is tantamount to success.

If you’d like to learn more about market cycles and how a strategy based approach can benefit your trading, consider joining us at The Closing Print.

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Options Traders Use Bollinger Bands for an Edge

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Vinny Gambini

Trade Fundamentals w/ Technical Analysis - CANSLIM method using high probability setups and Ichimoku Trend Analysis. Architect, Family Man and Father of three.