You Found the Stock, Now How Do You Trade It?

Every weekend the entire trading community spends their time avoiding their families and friends looking for the next big trade. If you are a technical trader like me that means looking at charts. One stock I found this weekend, the mattress maker Tempur Pedic (ticker: TPX), looked primed to break through a double top and extend higher. For a charts guy finding stocks going to new highs is better than getting your your favorite toy for your Birthday when you turned 6 years old. You cannot wait for the market to open for a chance to play with it. But finding the stock is just the first step. Here are 5 methods to consider when deciding how to enter this particular set up. The first three methods can be used if you have a non-margin, or cash account, and methods 4 and 5 apply if you do have a margin account. The chart I used this weekend is below including my analysis and a link to the full watch list is at the end.

Tempur Pedic, ticker: TPX

Tempur Pedic is pressing on the ceiling at 48.80 for the second time in a month. If it can get over 48.80 then it has a Measured Move target of 54.50. The Relative Strength Index is bullish and the Moving Average Convergence Divergence indicator is improving and about to cross higher, supporting further upside.

1. Buy the Stock – Pretty straight forward. It breaks resistance, you buy the stock.

2. Buy Call Options – Also pretty straight forward. Buy either the March or April Expiry 49 Strike, at the money calls, when the trigger occurs, giving upside exposure at a much cheaper cost and limiting the downside risk to the premium paid. The March 49’s closed at 1.05 and the April 49’s at 2.25.

3. Buy Call Vertical Spreads – This is a variation on method 2. Here you additionally sell an upside strike call, the 55 strike in this case, against the option you bought to reduce your cost on the trade. The 55 strike was picked because of the expectation that the stock would move to 54.50, where it will expire worthless. This works best on the April Expiry as there is more time value in those options, and would reduce the cost by 50 cents, or 25%.

4. Buy Call Calendar Spreads – This entry is through selling the near month above the money call and buying the next expiry call of the same strike. For example sell the March 50 call for 80 cents and buy the April 50 call for $2.00, or a net debit of $1.20. This is also a bet on timing of the move higher, as you are betting that the stock will not be above 50 on the March expiry, or you will be able to buy back the option cheaper than what you sold it for. This is betting on a slow rise.

5. Sell Puts – You could also bet on a fast rise by selling the March 55 puts for $6.80 or April 55 puts for $6.90 with the expectation that you will be able to buy them back on or before expiry at or near 50 cents. If the stock closes below 55 you would be forced to buy the stock at $55 but then your basis would only be 48.10, using the April puts.

So which way are you going to trade? Figure out your own style and then trade’m well.

Thanks to @NJHounds who followed me into the TPX trade today via calendar spreads for giving the inspiration for this article.

Top Trade Ideas for the Week of March 7, 2011: Bonus Idea with Links to Full Top 10

(As always you can see details of individual charts and more on my StockTwits feed and on chartly.)

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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