A question I’m constantly asked is, “how do you trade this type of market?” Well, if you must trade in this market then do it safely and yes that is possible. To me, this invariably means buying options. This way I know exactly what my maximum risk is, regardless of where the market goes or what my original trading plan was.
Now, let’s have a look what’s happening with the XJO, the index for the ASX 200. This index has been travelling sideways for the last 2 months in about a 250 point range between 3500 and 3750, with a short term bounce up to 3800.
If we look at a ProfitSource daily chart of the XJO with the Elliott Wave pattern applied, we can see that the index hasn’t reached the projected Wave 5 low of 3386 with 2 days to go. This could then cause the Elliott Wave to re-label into an ABC sideways pattern after the 22nd January. See chart 1.
click to enlarge
To take advantage of this I’m looking at a short term calendar trade on the XJO, where I sell the February 3600 Calls and buy the March 3600 Calls. The idea here is for the index to keep trading sideways until the February Calls expire worthless, then I can sell the March Calls for a profit. The February 3600 Calls traded on Monday the 19th at a high of $151 and the March 3600 Calls at $205 a contract.
The actual order instructions that I would give to the broker would look like this.
I would say to him, I want to place a debit spread. Buy to open 1, March 3600 XJO Call option contract and at the same time sell to open 1, February XJO 3600 Call option contract for a debit of $54 or $540 a contract, (XJO Index options have multiplier of 10). It doesn’t matter what the individual prices of the options are as long as my overall debit is $54 for the trade. This would tell the broker exactly what I wanted to do and it makes sure that I don’t end with just getting one leg of the trade filled.
I chose to use Call options because I believe that if the market does move suddenly, there is less of a chance of it making a large rise in the short term than it has of making a large fall.
Chart 2 shows an OptionGear Risk graph of the trade, where the black line shows us how much profit the trade will make per contract at February expiry, should the index be trading between about, 3350 and 3860.
click to enlarge
The trade plan with this trade is quite simple. If the index stays below 3600 up until February option expires, then I do nothing and then sell the March option the day after expiry. However, if the index is trading above the 3600 level coming into February expiry then I will need to close out the trade the same way I entered it, by placing the order as a spread trade. Only this time I should be receiving a credit for the spread.
Remember, you always have options