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Minyan Mailbag: How Predictive is the Action in Options?


Puts have a track record of foretelling disaster.


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Dear Professor Smith,

What kind of order do you use if you're buying a small number of calls near a stock's intermediate low? Tr
ailing stop at lowest low of last 12 days? Or a percentage stop, not trailing? Or some other type of stop?

Minyan Dan

Dear Minyan Dan,

For the initial purchase, if you're actively watching, and it's a liquid contract, I'd just use a market order - or something not to far off the market if you're eyeballing a level and the spreads are more the a $0.15 wide.

I'd start with a stop based on the stock price. I simply look at old lows, or whatever the support level might be (there might have been a spike so the support might actually be a bit higher than the intraday low and lower than the close), without any hard count of days. For intermediate term -- and that's become relative due to magnitude of moves -- it could be anything from 5 to 30 trading days.

Then, assuming you start to be right, you can start raising your stop. Whether it be a percent, dollar-based, or even to the next support level, would depend on your risk tolerance and price target.

Minyan Dan continues:

If you could give me some very brief answers on these:

1. Have you noticed, or is it your opinion lately, that options action has been more predictive than usual of stock surges or tankings?

For example, when somebody scooped a zillion General Electric (GE) puts at $5 strike about 4 weeks ago when the stock was about $12 .

2. And when the stock starts trading like its options -- like Bank of America (BAC) -- and option leverage disappears, is that a scenario that usually doesn't reverse itself?

3. How will your service, OptionSmith, be different or similar to Jud Pyle's service at I assume you will have alerts for unusual options activity?

I'll work to address these in reverse order.

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No positions in stocks mentioned.

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