International Journal of Economics and Financial

Issues
ISSN: 2146-4138

available at http: www.econjournals.com

International Journal of Economics and Financial Issues, 2021, 11(2), 88-91.

A Simple Options Trading Strategy based on Technical Indicators

Francesco Carlier*

Ministero dell’istruzione, Genova, Italy. *Email: [email protected]

Received: 03 January 2021 Accepted: 10 March 2021 DOI: https://doi.org/10.32479/ijefi.11144

ABSTRACT
This paper is devoted to research the validity of options strategies with a particular emphasis on weekly options. The author proves that options, when
traded successfully, could be a better substitute than buying or selling the underlying and that options with a good given volatility strategy and with a
well capitalised underlying stocks could give superb results. The author analysed a simple strategy using the simple moving average and the bollinger
bands on the US market. Then a new capital allocation method is explained with the target of maximizing the results obtained. For further comparison
the options strategy is compared with the same strategy made with selling or buying the underlying.
Keywords: Financial Markets, Options, Technical Analysis Indicators
JEL Classifications: G11; G15; G24

1. INTRODUCTION When a black swan event happen a leveraged cfds owner can
lose more than his initial investment.
Trading on financial market has always received a really
close attention from investors and researchers, nowadays an Conversely, a black swan event can give a really high change of
individual investor can use really advanced trading techniques margin requirement in case of writing naked options. Over the
using derivatives and leverage to better perform in markets. years researchers have used options for trading, (Sinha, N. and
Options since a long time have a special role in speculation W. Dong. 2011) but some came to the conclusion that options are
and in trading strategies, an investor can use them directionally only a cost for the traders and some thought that those derivatives
or for take profit on volatility changes. Options are especially could help traders outperforming the market. Guo (2000) in his
study ended that profits after commissions for delta neutral and
used in trading because allow investors to take profit even in
straddles were equal to zero. Hemler and Miller (2013) discovered
a neutral market and without a significant price fluctuation.
that buying the underlying and selling a covered call, creating a
(Anand, A. and S. Chakravarty 2007). Greeks are the quantities
synthetic put, could outperform buy and hold strategy.
representing the sensitivity of the price of options. An expert
investor could choose an option that has what he needs, for Technical analysis is a mean of evaluating trading opportunities by
example weekly out of the money options have a big time statistical trends and market patterns. A technical analyst believe
decay and a big Vega. Conversely, long time out of the money that if he can find a market pattern he could easily individuate
options have a much smaller time decay and a lower Vega. where the market will go. Over the years a lot of technical
Using options spreads in trading strategies could help investors indicators have been done, some better than others. (Ahmed S.
defining risk. (Bakshi G., Cao C., Chen Z. 1997; Chong, J. Alanazi and Ammar S. Alanazi, David McMillan 2020). Technical
2004; Eraker B., Johannes M. J., Polson N. G. 2003; Eraker, analysis, as highlighted in the review of Park and Scott H. Irvin
B., 2013). The highest loss is given by the width of the spread (2004), gave positive results: 58 studies on 92 indicated that using
and this give a big advantage over simple leveraged cfd trading. technical indicators could lead to profit.

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88 International Journal of Economics and Financial Issues | Vol 11 • Issue 2 • 2021

 Carlier: A Simple Options Trading Strategy based on Technical Indicators

The aim of the study was to take advantage of the flexibility of buying a call spread on vix when trading could be helpfull to hedge
options for maximizing return on investment on a strategy that the possibility of a black swan event. Another possibility is an
deploy technical indicators as bollinger bands and simple moving early close option if a 50% gain is already made. The comparison
average (50). strategy using directly the underlying consist of selling (buying)
it when the call (put) spread is written.
The first indicator was developed by Bollinger (2002), and it is
made by calculating a simple moving average of 20 days and 3. METHODS
writing at two standard deviations upper and lower bands. In
previous studies (Doran and Fodor, 2006; Dash et al., 2007, Us market data is used in this study. Implied volatility is taken
Alexander, S.S. 1961) gave mixed results: often it is not enough to from data and, when not available, estimated using historical
outperform buy and hold techniques. The SMA (50) is the simple volatility. The model for pricing options is the Black a Scholes
moving average with a parameter of 50 days. The aim of this paper model (Black, Fischer & Scholes, Myron S, 1973). Assuming a
is to test this strategy: when SMA (50) is above (below) the upper normally distributed market results price of call is calculated as
(lower) bollinger band, writing a call spread is profitable in the C (S,t) = StN (d1)–Ke–r(T–t) N (d2)
long term, and to highlight any possible problems about capital P (S,t) = Ke–r(T–t) N (–d2)–StN (–d1)
management and the selection of the underlying.
where
The starting hypothesis of this study is that trading with options St is the price of the underlying
is much more flexible than trading the underlying, options are a K is the strike of the option
loss only if the underlying goes strongly against the direction that r is the risk free rate, expressed annually
we estimated profitable with technical indicators. N(x) is the standard normal cumulative distribution function

2. THE STRATEGY St 1
ln + (r +  2 )(T − t )
d1 = K 2
The strategy needs the allocation of a risk capital and the following  T −t
writing of a put or a call spread.

Specifically it is necessary to trade using the already explained d 2 = d1 �  T − t

technical indicators. When SMA(50) is above (below) upper
(lower) bollinger band a call (put) spread (selling call (put) out of The starting capital for the test is 10000$. Analysis of data has
the money and the buying a further out of the money call (put)) been done with an ad hoc software created for it. The time period
slightly out of the money with an expiration date of 4 days. This of this study starts from January 2005 and ends on January 2013.
strategy can be done with index, stocks, commodities and forex. The analysed stocks were: Apple, SPY etf and Walmart. Options
The priority when using options is to use a well capitalized and were sold out of the money 0.5-1% both for call and put. The
traded underlying, this is extremely important because with a spread should yield 35-40% yield on capital allocated during
highly traded underlying there are lower bid ask spread. Selling high volatility periods and 25-30% during low volatility. Usually
a spread margin requirement for broker is equal to the spread’s a spread of a percentage point was taken. The results aren’t
width and could allow the trader to better managing the risk. accounting for selling commissions and bid ask spread because
Using options in this strategy offer a really high protection rate the price inserted was given by previous formulas. The analysis
because often, during black swan events there are movements out of the comparison strategy was done by confronting the data of
of daily normal distribution. In case of a such events a stop loss, the option strategy with those of the underlying strategy, Selling
that is often used to protect investments, isn’t helpful. This is a and buying underlying were made by utilizing a stop loss of 3%
big problem when working with high leverage because it could and a trade target of 3%. Commissions and spreads for this model
lead to a margin call from the broker. weren’t calculated.

The author evaluated two cash allocation methods. The first 4. RESULTS
consist of trading a 5% of capital each for each trade, the other
consist of allocating a fixed amount for every trade. There is a Apple results are quite satisfactory and in line with expectation,
substantial difference between those two methods and the results on 120 trade made, 21 were a total loss, and 2 were a middle
are subject to the compounding effect: in the first cash allocation loss. Winning percentage was 80.8% (Table 1). The yield on risk
method a series of unfortunate trade could lead to an important capital per trade is an average of 32.2%. Evaluating gains and
portfolio lost. losses it is clear that during high volatility periods the strategy
suffered some losses, while during low volatility better results are
Two high leverage methods are evaluated, a 10% and a 20% achieved. Both cash allocations method ended up with a profit:
allocation methods for every trade. the first method of 5% of capital netted a 141% gain while fixed
allocation gave an 80% (Table 2). Sp500 moved 18.7% during
Maximum trade positions opened together are 3, but not more than the same time. With a leveraged position, the first strategy,
one on a single underlying. When working with a high leverage 10% gave a 495% profit and for a 20% allocation gains were an

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 Carlier: A Simple Options Trading Strategy based on Technical Indicators

astonishing 1805%. Gains started to be substantial after 2008 distributed results, we can note how the second is greater than
crisis and loses were far less frequent. 6%. This performance tell us that this technical analysis strategy
is working correctly and validate the theory that this analysis
The strategy used on SPY resulted in 60 trades, 9 were a complete could lead to profit as highlighted before. Another issue found
loss and 2 were a middle loss and one ended neutral. Winning with the underlying strategy is the inability to work with a
percentage was 80.7% (Table 1). The yield on risk capital per trade high leverage for the problems explained earlier. Trading spy
is an average of 31.9%. The strategy yield similarly to Apple: gave a much higher performance with options revealing that
during low volatility profits were high and during high volatility leveraging it during low volatility periods could lead to high
suffered severe losses. Both cash allocations methods ended up gains. Options strategy give to the trader the opportunity to gain
with profits, 5% of the capital yielded a 48.7 while with fixed even if the market isn’t having a significant price fluctuation
allocation strategy the gains are 41.8% (Table 2). Consequential and this strongly diversify options strategies from buy and hold
loses affect the yield of the first strategy and the compounding techniques.
effect drastically reduce the gains. The 10% strategy gains were
205% and the 20% yielded 359%.
5. CONCLUSION
Walmart trades were 52.9 were complete losses, one ended with
Starting hypothesis were correct, options are a really flexible
a loss of 1/3 and one ended neutral. Winning percentage was
80.8% (Table 1).The yield on risk capital per trade is an average financial derivative for trading and could be an effective means
of 31.5%. The strategies gave a far lower yield, 5% strategy for trading if are supported by a correct use of technical analysis.
netted a 19.5% while fixed allocation fave a 20%. Those different Using leverage in low volatility periods often led to higher
results were given by a series of bad loses that compounded to profits. This strategy perform well in financial markets and the
a huge loss. 10% allocation resulted in a 35.8% gain while the author believe that it can be improved with some effort maybe
205 gave a 53.9%. selling naked options or using as described before as call spread
on vix to hedge black swan events. For further improvement a
All strategies better performed during low volatility periods. trader can evaluate selling call spread out the money, in case of
SMA (50) over upper bollinger band and buying a put spread
Comparison strategies gave the same amount of trades, but a out of the money. The strategy could be implemented with an
different result: Apple on 120 trades gives 69 winning trades, with important money allocation on low volatility periods while
a percentage of 57.5. Gains were 179.1%. The strategy with Spy using a far lower capital during higher volatility periods. It will
performed far worst giving on 60 trades a winning percentage be necessary to open maximum one trade during low volatility
below 50%, 46.7 for a total of 28. Gains were 19.5%, not much periods and not more than three on high volatility. Capital not
higher than buy and hold strategy for the same time period. used could be invested in SP500 giving to the trader a much
higher profit.
Apple strategy with options outperformed by 38.1% the underlying
strategy, validating the starting thesis about the flexibility of REFERENCES
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