A Microsoft Options Trade That Didn't Work -- What You Can Learn From It

When it comes to trading options on expected price moves in a stock, timing is everything, as this failed Microsoft options trade shows.
By Michael Thomsett ,

Last week we predicted a selloff in Microsoft (MSFT) - Get Report stock after the stock rallied on positive earnings news. We recommended a short-term options trade based on that prediction. Technical analysis seemed in our favor, as the stock had made a big gap above resistance on the earnings news, and there was an inverted hammer chart pattern.

There was a problem with the recommended trade, however: the use of a very short-term put option. The expected decline in the stock's price didn't occur in time for the options trade to yield a profit. The November puts might have been better because they had more time until expiration. The current Microsoft chart shows that the expected drop still has not happened.

http://contributor.thestreet.com/articles/1/submit?execution=eff2d989b-7b01-43a7-aa3a-a811b7dc4485s2

Even so, the stock could see a decline later. The price level is exaggerated, the stock still gapped higher than resistance and momentum shows the stock in overbought territory.

True, it did not fall in time to make last Friday's weekly put option profitable. However, it is possible to learn more about the trades that don't work out than from the ones that do. The purpose in these predictions is to show and explain the thinking behind the charting system, not to try for 100% profits.

The options-trading system employed here, called "signal correlation," relies on timing and chart signals, and not on implied volatility. A two-year study of this system yielded 91.6% profits on 587 trades, with an average annual return of 35%. A peer-reviewed paper explaining this system will be published in the next edition of the Journal of Technical Analysis. You have to expect losses to be mixed in with the profits, but the object in these predictions is to reveal the system, which relies on strong visual price patterns with exaggerated movement and confirmation of likely reversals to occur in the near future.

Based on the continued status of Microsoft, here is a new forecast: At some point in November, the stock should return to the range below resistance and once again trade at less than $48.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

Besides blogging at TheStreet.com, Michael Thomsett also blogs at theCBOE Options Huband several other sites. He is author of 11 options books and has been trading options for 35 years.  Thomsett Publishing Website

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