Perils of Chasing the Opening Price

Often times, there is a built-up surge of demand on the stock, driving prices high right off the opening bell. That works out great for an options trader if you can jump in early and secure your spot. We discussed this in an earlier edition of “SPY on the Market,” especially when I told you how to submit your purchase for a few cents higher than the ask. But what happens when you chase the price up and get filled for a high price?

When you really get filled on these runups is when the stock is receding. Getting filled on the pullback is not what you want, because that’s when the market is heading straight back down.

As the stock price escalates, so does the option price, but at a much higher rate. When you do eventually get filled, you may have paid considerably more than what the option was truly worth. You, and many others, got pulled into the euphoria of the trade by believing the stock will rise much higher. However, when it reverses, this quickly sucks the premium back out of the option.

The problem is if and when the stock pokes up back to that previous high, and your option price fails to climb back up to the level it was previously. The excitement of the initial rally is over, and so is the exuberance of the price.

For example, last Friday, Nov. 22, SPDR S&P 500 ETF Trust (NYSEARCA: SPY) busted out from $593.65 to top $596 in only 18 minutes. By 9:48, the “at the money” call option of $595 for next Wednesday’s expiration, Nov. 27,  ran up from about $3 to $4.02.

Then SPY dropped, volleyed much of the day and ran back up to $596 at 1:10 p.m. — in fact, even higher to $596.15. The option price, however, only hit a high of $3.61 at that time. How does that make sense? The stock shot up the flagpole higher than it was previously, but the option fell $0.41 short of its high!

The high-spirited traders early on pushed the price over the top in a classic case of supply and heavy demand. When the elation of the move settled down, and the stock moved in more “normal” patterns, the option responded in a more subdued manner. A subsequent wave took SPY down and back up to $596.10 at the end of the day, but the call option only hit a high of $3.23 —  even lower than it had been during the second wave.

This phenomenon happens all the time: SPY shoots up first thing in the morning, pulling in aggressive traders, yet leaves them hanging, should they not exit their positions quickly. The only way to combat this is to a) initially get in ahead of the move by placing your trade for slightly more than the ask, and b) stop chasing it up, should you miss it the first time.

Relax, as you know the stock will likely retrace, providing a better buying opportunity than getting head-faked into the lure. If you want it, wait for the bounce off support, then enter the trade. It’s just not worth the risk if you end up holding the expensive option. Not only will you get caught in the volatility squeeze, but you will also be lost in the time value, should you be holding it long after.

Some of our subscribers make staggering gains in this first run up of the day. They enter heavy right at market open with buy orders for slightly higher than the ask price. With hefty volume, the price escalates and they quickly take their profits, often amounting to tens of thousands of dollars. Mind you, they trade many contracts, likely more than the average trader. That said, as an example, had you entered conservatively on Friday’s trade at $3.25 and exited at $3.75, making 15%, that works out to $1,500 on a $10,000 trade. Extrapolated over the year, that is about $375,000. Would you be happy with half that? It’s a matter of believing in the trade, based on technicals and matched with fundamentals, sprinkled with 100% confidence in the move.

It’s not that difficult making money on the market, if you know how. We teach you how.

We discuss these and other issues in our Trading Room here.

Click here for information on the highly successful DTS Signal. Click here for the Pick of the Day and click here for the Inner Circle.

Not sure what to do? Click here for our Sunday Night Intro to Trading/Week in Review at 8 p.m., ET.