When you come across a stock that is trading in a channel, you have plenty of “options” when it comes to finding a strategy that could make you some nice short-term returns.
An easy rule of thumb is to use a bearish strategy when the stock is trading at the top of the range, and use a bullish strategy when it is at the bottom of the range. Unfortunately because this market has been so bearish, there are very few stocks that are presently at the high end of their range.
But that doesn’t spell defeat before you even get started. Quite the contrary – opportunities are plentiful; you just have to take an extra step to discover them.
Sometimes these trading channels have other support and resistance areas in between that can help you determine if there is a good chance the trend will continue to either end of the channel. Today I’d like to share with you a trade idea from our newsletter, the Market Taker Edge, that fits the bill to a “T” – Aetna Inc. (NYSE:AET).
Like a lot of stocks, AET has been caught in a sideways trend. Since the beginning of August, the stock has drifted between $34 and $42.
The stock is trading below its 8-, 20- and 200-day simple moving averages, which makes it bearish by most traders’ accounts. Right now it is in the middle of that range at about $39, where it has some support and resistance, with the declining 8-day simple moving average to potentially prevent the stock from going higher.
With the stock trading here at $39, one way to ride this slide is to buy the AET Dec 39 Puts for $1.13 or less.
If AET can break through and hold the $39 area, it should probably be able to test the low end of the range, which is $34. If the market continues to be bearish, this option could profit quickly from the continued slide down.
The long put strategy is pretty straightforward. The trade profits when the stock falls and the put premium increases as the AET option moves farther and farther in-the-money (ITM). Maximum profit is almost unlimited only because AET can only fall to $0 (which is highly unlikely) and the maximum loss is $1.13 if AET finishes at or above $40 at December expiration.
Consider exiting the position if the stock moves above $40, which is above all the moving averages, or by the end of the week if the position is not profitable due to December expiration, which is Dec. 16.