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I often have people ask me why I would buy an outright call instead of a call spread (where I would be buying one call and selling a higher strike call with the same expiration).  There are a few current market charts that can really help me explain the benefits of each right now, and so I’d like to dive into each.

A call spread will give a lower entry price since there is less upside to the position.  So, to enter a call, I want to find a trade with incredible upside relative to the market expectation.  That means I want low options implied volatility – implied volatility is the future expected movement of a stock, and so when that level gets low, the options get very cheap and can provide tremendous leverage.

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The VIX right now is near lows, but could go lower.  To enter outright calls, I want to see that level near lows for the underlying I am trading.  For now, a broad market view is a good starting point for evaluating implied volatility:

So, onto two sector charts that I am watching very closely.  The first, XLF (the S&P 500 Financials Sector SPDR) is consolidating in a tight range, particularly over the last month:

 

Given this, I want to see a technical break out by the ETF making a new high (above the high from December 4th, 2020 at $29.03).  This tells me that the ETF is moving from trendless to potentially explosive, and an outright call position would suit me very well.

 

Let’s look now at the technical chart of IWM (the Russell 2000 Ishares ETF):

Small cap stocks have continued to grind higher since the election, with a clean trend in place.  Here, I can use a call spread to try to target the expected move over time given the current pace of price increases.  Since I can set a target price, I can get great leverage while reducing my initial cost by selling a call that I do not expect to finish in-the-money.

 

The specifics of each trade are a bit too in-depth for this particular e-mail as there are many more parts of the puzzle.  But, I’m always happy to discuss my trading methodologies including trade structure, risk management, trade sizing, hedging, stop-losses and more.  If you want to know more, send me an e-mail!

 

Keith Harwood

Keith@optionhotline.com

Keith Harwood

Author

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