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  • Dani

Catching A Falling Knife

Updated: Nov 9, 2020

Professional traders know that you shouldn't try to catch a falling knife. However, when you get a buying signal after a big drop ("harsh winter") you may want to catch the SSC.

This technique is one of the most practical money maker signals that Ken is teaching.

The most important thing is to define your maximum loss before you enter the trade, so you wont get caught in another leg down. This creates a problem if the stock is very volatile after the big drop, because you can easily be stopped out, and then the stock can rebound without you, which is very frustrating.

Another important point is that it is difficult to take an aggressive play when fear is high, so your position sizing tends to be quite small at these times. This is even more true if the correction doesn't happen on the same day, and then you need to scale down your position sizing in order to fit your swing PS.

In the following example I will show you how using options can solve these problems and allow you to capitalize on opportunities like that.

Ormat Technologies ("ORA") broke an important support level and crushed down 7% yesterday. It is important to say that no news came out, and it is reasonable to assume that after holding support at 58 (which was march low) for 6 month, many stop loss orders were triggered and caused that sharp move down. The rational for the trade is that maybe it is just a bears trap, and there is opportunity to buy value here.

Looking at the 5min bar chart, you can spot a SSC and RLXD around 54.5-55.

If you want to go long in that point of time, you can use options to take that opportunity, while limiting your risk and maximizing your capital efficiency.

Instead of buying 4000 Shares for 220K, and being at risk of being stopped out quickly, I could take the following option positions:

  1. Long 20 Call 55 for 3 days that cost 0.85$ each - for a total of 1700$ and BE at 55.85 for the next 3 days.

  2. Long 10 Call 55 to 1 month that cost 2.5$ each - for a total of 2500$ and BE at 57.5 until next month.

  3. Long 10 Call 55 to 6 months that cost 5$ each - for a total of 5000$ and BE at 60 until Mar. (This position also fits my long term game plan for the vaccine, and a part of my will to buy value before the vaccine is announced).

These 40 Calls cost together 9200$ and give me the same exposure as holding 4000 shares (2000 for 3 days, 1000 for 1 month & 1000 for 6 months).

As the stock rebound the following day, I could sell 2000 shares at 57 against the 20 short term Calls, and lock in 2300$ profit which pays for the 1 month position.

It is some version of Ken's core&turbo technique, applied to using options.

To conclude, using options, you can limit your risk, avoid being stopped out in volatile market, and take a more aggressive play than you could handle from a psychological perspective when you are trading the underlying asset.

It doesn't mean that I won't cut my hand from time to time, by it's going to be feel like paper cuts and not a real knife.

October 7th UPDATE:

and off it goes...

November 9th Update:

Last position (Mar): 4R winner and counting....

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