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Taking advantage of options on ETFs

We’re going to talk about something a little different…

We’re going to talk about an options setup on a trending ETF. And the one that we’re talking about here is the daily time frame (or end of day time frame) on the SMH which is the semiconductors ETF.

What exactly does all of that mean…?

The semiconductor ETF includes a high concentration weighted group of stocks that represents the semiconductor index. Keep in mind, Gang, it’s a liquid ETF which is really important.

So what we did is we focused on a pullback within this uptrend.

Now as for the trade, let’s focus on the where, why, and how of it…

The “Why”:

So first of all the why is pretty simple: when the market’s heading higher we want to keep a bullish directional bias. In this case, the market was heading higher. Then it began to chop around a little bit, which is oftentimes when a lot of traders get really sliced and diced up.

Don’t fall for that… that’s why for this trade we thought “long only.”

So where’s our opportunity going to come from?

The opportunity is going to come as the market pulls back.

So remember if the market pulls back, and you want to be a buyer, imagine this as if it’s going “on sale.” So where are we looking for the opportunity? When the market starts to move down into the zone as close as possible to the 34 period exponential moving average on the high, the close, and the low (a.k.a. the wave).

Now we did see a few layers of support in the 73 area — which was the trigger.

So What Are We Going To Do?

Remember, Gang, I mentioned this was an options on ETF trade.

And let’s talk about it as in “bearish velocity” — the market actually gapped lower. When that happens, most people freak out. But we didn’t.

Why

Because we knew the trend was higher before the chop, and we knew based on analysis that this was likely going to be a continuation. Those add up to signal that the SMH “was going on sale.”

You can see that highlighted with the green arrow below:

Playing The “Sale”:

In this instance, a call option allowed us to take advantage of the SMH with leverage and at a lower price. So rather than buying the SMH at its $173 share price, we bought an option that allowed us to control the SMH with leverage and at a lower pierce.

So we were able on that move lower, to pick up the SMH at about $6.50 per option. That’s $650 per option. The option that we purchased was the 175 call specifically with an expiration in November.

Then a week later that option was trading for $17 — a $10 increase.

That $10 increase is a $1,00 per option increase in the SMH only a week later.

Looking Forward:

Now in order to have the cost of about $6 – $6.50, there are a couple strategies you can use:

  1. Long calls
  2. Call verticals
  3. Put credit spreads

This particular setup is ideal for a call vertical. The second leg of the call vertical is simply selling an out of the money call which allows us to have a lower cost basis for the trade.

And that’s exactly how we played this trade with a call vertical.

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