How to Use Technical Analysis
to Sell Puts

An Example Where Incorporating Basic Technical Analysis Resulted in Me Doubling My Annualized Returns, Ringing the Register Twice on a Trade, and Still Freeing Up My Capital More Than One Month Early

Today, I want to show you a couple of stock charts that are pretty eye-opening.

Now, I know that technical analysis isn't everybody's thing.

But I'm a firm believer that the most profound truths are always simple.

Not simplistic, mind you, but clear and uncomplicated.

So the technical analysis I practice is pretty basic stuff - I'm mostly looking for trading ranges or channels, likely support and resistance levels, and oversold or overbought indicators.

That's it.

But you know what? I find that's all I really need, and the results speak for themselves.

Let me show you what I'm talking about.

Identifying a Trading Range - TOL

Here's a chart on luxury home builder Toll Brothers (TOL) I put together near the end of December 2014:

technical analysis and option trading example toll brothers

It shows that the stock had been in this nice $30-$38 trading range going on close to 2 1/2 years.

(Nice for options-based value investors who can exploit these kind of situations. Not so nice for traditional, stock-only investors who have just been spinning their wheels in the stock over the last 2 1/2 years.)

Now, one thing you'll notice is that the trading range I've identified isn't perfect.

For example, in 2014, in the late February and early March period, TOL briefly traded well above $38.

And then later in the year during the mid-October market swoon, the stock also briefly traded below $30/share.

Additionally, throughout much of 2013, the stock really couldn't trade past the $35 level.

But who cares?

The Purpose of Technical Analysis

The purpose of technical analysis isn't to precisely pinpoint exactly what a stock is going to do and at the exact point in time it's going to do it.

The purpose of technical analysis is to simply help us determine what's more likely to happen and what's less likely to happen in the near term.

And as it relates to option trading in general - and more specifically selling or writing puts - that's all we really need.

Here's a very simple formula - sell puts at support and buy them back at resistance.

OK - there's more to what I do than just that, of course. In fact, I offer a 5 week training course that spells out my entire criteria for selecting, setting up, and then managing short put trades from a value investing oriented perspective.

But the point is, basic technical analysis is a valuable tool that I use to help me time my set ups and my trade management decisions - and it can help you with your timing as well, even if your trading or investing approach is different than mine.

And the chart in the section below will show you what I mean.

Basic Technical Analysis and Writing Puts

The technicals weren't the only rationale for my short put trades on TOL.

I also felt the stock was reasonably valued, the underlying fundamentals were sound, and that it was a well run business with plenty of financial muscle.

In short, TOL was an ideal candidate to write puts on, since puts are essentially insurance policies.

My approach is to only write puts - or insurance policies - on high quality companies when I can identify multiple reasons why the stocks of those companies are unlikely to trade lower, or lower by much, in the near term.

In the case of TOL, that meant initiating my short put position when the stock was trading or or near the lower end of that trading range, and potentially closing that position if or when the stock traded back toward the upper end of that range.

A put loses value in three ways - the passage of time, a rising share price, and a decline in implied volatility levels.

There's nothing necessarily wrong with leaving be a short put position where the underlying stock has traded higher. Often, the position will expire worthless as you originally hoped or planned it would.

But when the short put in question rapidly loses value from both a rising stock price and regular time decay, you'll find that you can often lock in a majority of the trade's potential gains in a fraction of the time.

And then free up your capital much earlier so you can go out and exploit the next opportunity.

And sometimes, when things work out just right as they did here, you get the opportunity to re-enter the trade and ring the register twice.

So check out this chart that shows a pair of documented trades I ran inside a model portfolio in The Leveraged Investing Club.

Super Sized Gains Thanks to Technicals

The very first point I want to make is that I got VERY lucky on the timing on these two trades.

Yes, when and where I entered and exited the trades was based on monitoring and analyzing the TOL stock chart, but I don't want you to think that the charts are always perfect, or that I'm suggesting that I always nail the top or bottom in a trade.

Granted, this example looks pretty textbook, and I only wish all my trades worked out so flawlessly.

The important takeaway here is that you don't have to be perfect (nor should you expect to be). It's enough that you're in the general neighborhood of getting the timing right. Believe me, that's all you really need to make good to great returns.

Now, speaking of returns, let's see what these two trades produced.

Doubling My Already Great Returns

I personally target 15-25% annualized returns on my short put trades. To me, this is a very doable target.

It may not be those mythical super sexy triple digit real (vs. annualized) returns that internet marketers hyping high risk trading systems like to tout.

But if you consistently string together 15-25% annualized trades, you're going to do very well over the long term.

In fact, as I originally set up both versions of this trade, they were both projected to return 15-16% annualized returns over their expected holding periods if held until expiration and assuming the put in question expired worthless (i.e. if TOL was trading at or above the strike price of the trade).

But look what happens when you're able to shorten the holding period, free up your capital, and still lock in a majority of a trade's original maximum gains:

TRADE #1: $32 FEB 2015 Short Put

ENTERED: 2014-12-29

PRICE: $32.66/share

EXITED: 2015-01-13

PRICE: $36.04/share

RESULTS: 37.98% Annualized - 15 Days

TRADE #2: $31 MAR 2015 Short Put

ENTERED: 2015-01-16

PRICE: $32.56/share

EXITED: 2015-02-06

PRICE: $36.55/share

RESULTS: 33.60% Annualized - 21 Days

Again, the technical analysis we incorporate inside The Leveraged Investing Club isn't particularly complicated or grueling.

And more importantly, it doesn't have to be in order for us to achieve our objectives (generating high yield income from low risk stocks, acquiring high quality stocks for half price or less, and rapidly accelerating our dividend income, yields, and growth rates).

How about another example? Here's one where I usaed basic technical analysis to lock in 20.43% annualized returns over 17 days.

Follow @LeveragedInvest