Options traders tend to be people who love technical indicators. I, too, love those indicators and their relationships to the mathematics and physics precepts that I loved in school. I believe they reveal something about the underlying strength or weakness of the markets. However, we options traders may be in for some rocky periods if we ignore everything but our technical indicators.
One example can be drawn from my earliest days as a day trader. Although I traded many stocks, I soon learned that I preferred to focus on a few so that I could learn how they reacted intraday. Enron was one of my preferred stocks, if that tells you how long ago that was. Although I watched charts, I also manually wrote down prices at regular intervals for a few days to give me a sense--an actual tactile sense--of how the stock's prices ebbed and flowed. While actively trading it, however, I would sometimes get surprised by price action I didn't understand.
After a few weeks, I figured out that this surprising volatility was happening on one day of the week. That day of the week was the day that crude inventories came out. I hadn't realized the impact that those crude inventories could have on Enron's stock price.
Not paying attention to that fundamental report's impact treated me to some extra volatility that I hadn't been prepared to face. After that, I made decisions each week about whether I wanted to hold my Enron trade open as that report approached.
Within a few years, I had decided that I preferred trading options on the major indices. That didn't mean that I could ignore fundamentals.
I was prepared to pay attention to fundamentals on June 25. The day before, I had positioned my trade to be prepared to handle early volatility. The table below, displaying economic releases due the next morning, explains the need for such care.
Detail of Pre-Market Economic Reports on Wednesday, June 25, from Forex Factory:
Final GDP had disappointed and disappointed badly. As futures action indicated might happen, indices such as the Russell 2000, the underlying for my then-live trade, gapped lower at the open. I typically make my adjustments only at the end of the day. However, if I think there's going to be a rout to the downside or a screaming rally, I will sometimes make incremental adjustments to help the trade endure the day's trading without being too far underwater by the end of the day. I don't like to do that unless I'm pretty sure that the early direction will be maintained throughout the day. That's a hard thing to do in our current market climate, particularly with the RUT. Where do I go next in such situations?
At such times, I want to look at volume patterns. Many typically used indicators are built around ballistic-type studies of price behavior. They all tend to give versions of the same information because they're based on the same information. Volume does not directly correlate to price behavior, however, so it gives an independent view. You can have heavy or light volume on a down day, for example. However, what I'm looking for in a situation like the one seen on June 25 is whether the volume patterns indicate a strong directional bias. On a down day, am I seeing more declining than advancing issues, more down volume than up volume, and even more capital devoted to declining issues than to advancing issues?
Early Volume Patterns on the RUT on June 25, Information via Think-or-Swim:
Remember that futures action and the early price action, too, were negative. However, that downward bias was not reflected in volume patterns. This information stayed my hand. I did not make an incremental adjustment to my trade so that it could better handle further price drops.
What was I seeing? Advancing and declining issues were about even. Advancing volume was larger than declining volume, meaning that buyers of advancing issues were buying more than sellers were dumping on declining issues. Capital spent on advancing issues was outstripping capital involved in declining issues. This information is far from fool-proof, especially in the early moments of trading. However, the information told me that a bounce attempt might be made. Right or wrong, this fundamental information kept me from making an early incremental adjustment before my typical EOD adjustment period. It told me to practice my SOH (sit on hands) skills.
This decision to wait out the early action was especially relevant since my trade was not in any trouble at the moment. Note that this article was roughed out during the morning in question, so visuals were snapped at different times, as I was writing.
Live Trade about 90 Minutes after the Open, Graph by OptionNET Explorer:
This methodology is not fool-proof, and I would be checking volume patterns during the day if an outsized move seemed threatened. However, volume patterns did not seem to corroborate the early weakness, and this trade can usually wait until an EOD adjustment.
Not everyone has access to all the security-specific information about volume that I displayed. Before I had the specific information found on think-or-swim, I watched the NYSE, Nasdaq or other advance/decline and up/down volume information. Such information can be found on Yahoo! Finance and other sites.
The point? Do be aware of important and potentially market-changing developments such as upcoming FOMC decisions or other economic announcements. We can't always predict geopolitical developments or know what some rogue FOMC President is going to say, but we can know when potential market-changing releases are scheduled. Jim Brown provides a wonderful analysis of such upcoming events each weekend, and the other writers often update during the week, too, and warn when to expect such developments. Forex factory and Econoday provide economic calenders.
Also, find another trusted indicator that does not correlate to the other ones based only on price. Perhaps for you that will be the put/call ratio. Although I don't fashion myself any kind of expert on put/call ratios, I do check TOS's "sizzle index" to see if more options are being bought than normal, and if puts or calls are being bought at the ask or sold at the bid more often. That tells me whether people are dumping puts for any price they can get or scrambling to buy them for any price they have to pay, for example.
Think-or-Swim Information on Puts and Calls:
This information on this chart tells me that the great majority of call and put traders that morning of June 25 (87 and 80 percent, respectively) were trading between the bid and the ask. They were neither hurrying to dump any options or scrambling to buy them at any price. They were taking options position at a run rate a little above the average for that time of day, however, with the Sizzle Index at 1.17. That Sizzle Index has not changed in many days for the RUT, so I think that it is currently not a trustworthy indicator.
Don't make trade decisions on the tactics I've presented here. Find your own. The point is just that even we technical traders need to pay attention to economic announcements. We might want to locate information that either corroborates or refutes the information provided by our technical indicators.