Moving averages trading is a concept of trying to time the trend of the underlying security to pick movements up and down in the security to profit by that trend. When using option strategies for income, applying moving averages trading can be especially profitable. This article examines using the 10 day simple moving average in combination with the 20 and 30 day exponential moving averages to time put selling opportunities in stocks. By using the 10-20-30 day moving averages trading strategy an investor can time the movement in a security such as a stock to pick the best moment to apply option strategies for income such as selling puts and buying them back or closing them early for a profit.
This strategy could easily be used for any type of security and not just for put selling opportunities but to also engage in covered calls, naked (uncovered) calls, credit spreads and simple buying and selling of a security. I have used this moving averages trading strategy for years with a variety of option strategies for income and capital gains.
This moving averages trading strategy was developed after reading the moving averages trading strategy of selling covered calls by Dr Samir Elias in his book Generate Thousands. After reading the book, I spent some time looking at the moving averages trading strategy and studied various stocks and attempted to apply the strategy to see if it was effective. While there is never a guarantee, often there is a pattern that option strategies for income can benefit from. This article was put together with the help of Troy Mills of http://troysmoneytree.wordpress.com.
I have revised this moving averages trading article several times to keep updating it with my findings as the 10-20-30 moving averages trading strategy is something that I use daily in some my stocks.
Moving Averages Trading For Option Selling
10-20-30 Moving Averages Article Overview
The 10-20-30 Moving Averages Trading Strategy uses moving average cross-over points on a stock chart to try to pinpoint specific times to sell Covered Calls, sell Puts, and buy back both Covered Calls and/or Puts that have been previously sold. The objective of this type of moving averages trading strategy is to capture the majority of the value of the sold option.
Who Might Consider Using This Moving Averages Trading Strategy
A) Long term holders of stocks, to decide when may be the best possible time to sell a covered call with a higher chance of not being exercised.
B) Long term holders of stocks, who have sold covered calls AND want to determine the best time to buy back the covered call as they DO NOT want their stock exercised.
C) Investors who write Naked (Uncovered) Puts and Naked (Uncovered) Calls for income with the objective of NOT being assigned the underlying stock but just earning the option premium.
D) Any investor who has a financial investment in everything from equities to bonds to ETFs and even forex. Where ever charting is available, the 10-20-30 moving averages trading strategy can be applied.
E) Any investor using a wide variety of options strategies for income and/or capital gains.
Moving Averages Definitions:
Simple Moving Averages (SMA) – A simple, or arithmetic, moving average that is calculated by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods. Short-term moving averages respond quickly to changes in the price of the underlying, while long-term moving averages are slow to react. In other words, this is the average stock price over a certain period of time. Keep in mind that equal weighting is given to each daily price. Many traders watch for short-term moving averages to cross above longer-term moving averages to signal the beginning of an uptrend. Short-term moving averages (e.g. 10-period SMA) act as levels of support when the price experiences a pullback. Support levels become stronger and more significant as the number of time periods used in the calculations increases.
Exponential Moving Averages (EMA) – A type of moving average that is similar to simple moving averages, except that more weight is given to the latest data. Exponential moving averages are also known as “exponentially weighted moving averages” or EMA for short. These types of moving averages reacts faster to recent price changes than simple moving averages. The 12- and 26-day EMAs are the most popular short-term moving averages, and they are used to create indicators like the moving average convergence divergence or MACD for short and the percentage price oscillator or PPO for short. In general, the 50, 100 and 200, day exponential moving averages or EMAs are used as signals of long-term trends either up or down in the market.
Select this Moving Averages link to read more about the concept behind moving averages.
The Theory Of Applying The Moving Averages Strategy:
The moving averages strategy being discussed in this article, is using the 10 day SMA (simple moving average) and the 20 and 30 day EMAs (exponential moving averages). The idea is simply when the 10 day SMA (simple moving average) crosses down the 20 and 30 day EMAs (exponential moving averages) , the stock is trending down and this would be a peak time to sell a covered call or buy back a sold put. With the reverse, when the 10 day SMA (simple moving average) crosses up and over the 20 and 30 day EMAs (exponential moving averages) the stock is moving back up which is a prime time to sell naked puts and buy back any sold covered or uncovered (naked) calls.
While there is no guarantee with any strategy, there does seem to be some benefit in studying the moving averages strategy and applying it on a variety of stocks.
I found through paper trading, that like all strategies the moving averages strategy doesn’t always work. For this reason I prefer to use the moving averages strategy only on stocks that I would own if the trade didn’t work out and I was assigned shares. Overall there does indeed seem to be some value to at least putting the moving averages trading strategy in my tool bag of trading strategies to use.
I believe the best way to see the moving averages strategy at work is through examples.
10-20-30 Moving Averages Trading Test Microsoft Stock (MSFT)
Chart 1 below shows Microsoft Stock over a period from Dec 2008 to May 2009. Studying the Microsoft stock chart, I was able to pin point the period to sell calls and when to sell puts. One of the important things to remember is that when options are sold, they are not always held to expiry, but often bought back to close out the position and lock in the profit. The whole concept is to earn as much premium as possible from the sold option and then let time value in the sold option erode as the expiry month approaches. But when the trend changes, buy and close the position early to avoid losing the option premium which will increase rapidly should the stock turn and begin to fall, in the case of a sold put or rise, in the case of sold call. By closing early the investor removes his capital from risk of assignment and can look elsewhere for another option selling opportunity through using the 10-20-30 moving averages strategy.
Let’s look at this example to explain the concept of closing the option early to avoid a trend change. This is a fictitious stock.
Jan 22 – Stock ABC is trading at 25.55 and in an uptrend according to the moving averages strategy. Investor sells the Feb 25 put for $1.00. This put option will expire Feb 17.
Jan 30 – Stock at $25.88 – Put value trading for $0.85 The put premium is decreasing as the stock moves higher AND the expiry of February options moves closer.
Feb 5 – Stock at $26.10 – Put value trading for $0.25 The put premium continues to decrease as the stock moves higher AND the expiry of February options moves closer.
Feb 10 – Stock at $25.55 – Put value trading for $0.55 The put premium is increasing as the stock moves lower AND the expiry of February options is still 1 week away.
You can understand from the example above that there was a good point when the investor should have bought back the sold put and earned as much income as possible from the trade. It was around February 5. The same thing happens with a sold call. It falls in value as the stock falls but rises in value as the stock rises. Therefore it is important to keep a watch on sold options to earn as much premium as possible from them while being aware of the possibility that the stock trend can change which often will quickly erode the premiums earned in the sold option.
Microsoft Stock – 10-20-30 Moving Averages Strategy Chart 1 – Call Selling
You can see from the Microsoft stock chart below that the Dec 22 to Jan 21 call resulted in only a small gain. Through paper trading I determined that I was able to increase the odds of the gain being larger in the option if I added two additional rules to the 10-20-30 moving averages trading strategy.
10-20-30 Moving Averages Strategy Chart 2 – CHANGES TO STRATEGY
Chart 2 below shows these two changes to the 10-20-30 moving averages trading strategy.
A) Buy back the call earlier, when the 10 SMA FIRST turns UP (as shown in the chart below) being aware that the turn up may just be short-term and the trend may continue lower AND/OR
B) Whenever there is a decline in the CALL price to a gain of 75%, buy back the call. In other words if the covered call was sold for .50 cents and it had decline in value by 75% or in this case to .13 cents, then buy the call back. This would protect the sold option from the possibility of assignment and lock in the gain on the call. The same could be applied to the sold puts.
10-20-30 Moving Averages Strategy Chart 3 – Put Selling
Chart 3 below shows how I reversed the moving averages trading strategy to sell puts on Microsoft stock without wanting to own shares.
Basically when the 10 day SMA begins to cross the 20 and/or 30 day EMA upwards, then I sold Puts. When the trend moves in reverse I buy back the sold put and close my contracts. This locks in my profit and frees up my capital from any possibility of assignment.
10-20-30 Moving Averages Strategy Chart 4 – Put Selling
Chart 4 below shows how I can take the same additional rules from chart 2 of closing my sold options early by buying them back and apply the same concept to my cash secured puts.
Basically buy to close the naked put contracts when I have made a 75% profit or when the 10 day SMA turns down.
10-20-30 Moving Averages Trading Strategy Summary
Based on the above charts and my paper trading, the 10-20-30 moving averages strategy does have merit. Like all strategies it does not always work and it seems to work better with specific stocks. To see this strategy in an actual trade, I have used it for my Research In Motion Stock (RIM stock) trade since 2009. You can review the moving averages RIM Stock trades here.
As well this article on using the 10-20-30 Moving Averages Strategy on Cisco Stock over a 5 year period is quite good and shows what any investor can accomplish using the 10-20-30 moving averages trading strategy.