One of the beauties of technical analysis is its ability to quickly generate trade ideas off actionable price levels like support and resistance. Upon properly identifying these key lines in the sand, traders can structure positions with a better-than-coin-flip chance of success. Additionally, when using these levels, it’s easy to identify when one’s original thesis has been proven wrong — and thus when one should exit the position.
Take the recent action in SPDR Gold Trust (NYSEARCA:GLD). Over the past year, it has formed a descending triangle on the weekly chart with key support forming around the $150 level. Each and every attempt by the bears to breach this zone has been denied by the bulls.
This generates an actionable price level in the chart to construct a few “if-then” statements. If GLD remains above $150, the path of least resistance is likely sideways to higher. Alternatively, if GLD breaks below $150, the path of resistance is likely lower.
To profit from the theory that $150 will hold as support, an option trader might consider selling out-of-the-money bull put spreads. The bull put spread consists of selling a higher strike put while buying a lower strike put of the same expiration month.
The trade is initiated at a net credit, which represents the maximum potential reward and will be realized if the stock remains above the higher strike put option. The max risk is limited to the distance between strikes minus the net credit and will be incurred if the stock falls below the lower strike put by expiration.
Click to EnlargeFor example, traders could sell the Sep 150-145 bull put spread for a 90-cent credit. If entered at this price, the max reward would be capped at $90 and realized if GLD remains above $150. The max risk would be $410 ($5 – 90 cents) and incurred if GLD falls to $145 by Sep expiration.
If GLD pulls back in the coming days, traders should be able to sell the spread at an even higher credit.
To manage risk, traders could close the position if GLD breaks below the $150 price level.
At the time of this writing Tyler Craig had no positions on GLD.