Tips For Trading Options With Elliott Waves

from Elliott Wave International

In this new interview, Wayne Gorman, the head of our Educational Resources Department, offers tips and strategies for options traders.

Alexandra Lienhard: Welcome to ElliottWaveTV. I’m Alexandra Lienhard, and today I’m joined by Senior Tutorial Instructor, Wayne Gorman, who is also the head of Elliott Wave International’s Educational Resources Department. Wayne, thanks for being here today

Wayne Gorman: Thank you, Alex. It’s great to be here.

Alexandra: Now, you have more than 30 years of experience as a Wall Street risk manager. You’ve also taught hundreds of people all over the world how to use the Wave Principle, both in online courses and in live events. And one of the areas that you have expertise in is using options in conjunction with Elliott wave analysis. I wanted to ask you about some specific market situations where you find it more beneficial to use options, as opposed to, say, futures contracts?

Wayne: Well, there’s a couple different types of situations. The first, certainly, is in corrections, where you have a lot of up and down movement and it’s not very directional. Sometimes it’s beneficial to use options because of the volatility. You can take advantage of that.

Futures, outright long and short, is best in third waves and fifth waves, where the direction is clear. It would almost be a waste of money to use options when the direction is more certain and clear. There are times where you’re using Elliott wave where you know the trend, but in the very short term, the market could go either way, and sometimes having options gives you that flexibility to be positioned for that.

A classic case was recently with the election, we were in a situation where we were in a second wave down in the stock market, and it could’ve gone a little further down — or it could’ve stopped and rallied. That’s a good situation for options. One of my favorite strategies is called the “short iron butterfly.” You buy a put and a call, so you’re ready to go up or down, and then you hedge that by selling a put and a call out of the money. After the election, that strategy — which normally only makes money on one side — would’ve made money on both sides, because the market went down and then it came right back up. There are other strategies like that where you’re just not sure, or you’re at a critical juncture. So it just depends on the situation.

Alexandra: What markets work best for these options strategies?

Wayne: Many markets work well. Option strategies aren’t restricted to any particular market, as long as there’s a lot of liquidity in the market, good volume; volume is important. So, I wouldn’t say any one in particular, but certainly highly volatile markets are good if you’re long volatility with options. I wouldn’t restrict it; as long as you have a deep market it’s fine.

Alexandra: Now, on the flip side, are there options strategies that you recommend people stay away from?

Wayne: Yes, I’m glad you asked that. In my courses, I stress that I do not like to take certain option positions where you’re net short options — because if you’re just short a call or short a put, then your return, what you can make, is limited. You can only earn the premium that you’re received for selling the call or the put; your risk is unlimited. I always recommend that if people are going to short options that they have something else on the other side. For example, let’s say, you’re long a stock. You think the stock may go sideways and you want to earn some money. You could sell a call against that. And you don’t have unlimited risk because you’re covered, you own the stock. If the market goes way up, what you lose on your call you’ll make back on your stock; it’s called a covered call. Those strategies are fine. But what we call a naked short is, I think, too risky. Most people lose a lot of money on that.

Alexandra: Last question for you, if you could sum it all up, what is the one greatest benefit you find using options in conjunction with your Elliott wave analysis?

Wayne: I would say at certain junctures where the market, accordingly to your Elliott wave analysis, presents two valid wave counts. In the long-term, both counts point in the same direction, but in the very short term, they point in opposite directions. So it’s very hard to position in futures; you can’t be long and short at the same time. It’s those kinds of situations when I recommend using options. Especially also if you’ve missed a lot of the move, maybe you’re well into a third wave or a fifth wave, and your stop would be so far away, but you still want to participate — that’s sometimes a good moment to use options, because you can limit your risk and you don’t have to have a big stop-loss facing that type of risk.

Alexandra: Great, thanks Wayne for taking a couple of minutes to talk today. I appreciate it.