This is a setup I often use to spot a quick reversal in a stock after steady decline. This stock trading setup is described in detail
in the book "Explosive Stock Trading Strategies".
The setup involves the use of three readily available indicators: (1) Price Oscillator. (2) Accumulation Distribution
and (3)Channel Index
To pinpoint the reversal point look for :
(1) Narrowest clearence between the Price Oscillator and Accumulation Distribution.
(2) The Channel Index shows ppositive price divergence. ie: The index moves higher with a
flat or declining price
(3) The stock trade entry is determined by the intersection of the vertical line joining the narrowest clearance
point with the Channel index and price.
(2) A long call option entry point is determined when the Accumulation/Distribution line turns up after
a brief drop following the narrowest clearence area.
In the chart below for the stock Z, the vertical line joining the narrowest clearence point and the Channel index intersects the price near
$33 late March which is the stock trade entry.
The long call option trade entry is where the vertical line starting from an upswing in Accumulation/Distribution
intersects the price near $36 around April 19. In this case you can do one of three things
(1) Sell a higher strike in the money put
(2) Buy an out of the money call
(3) buy in the money call. $35 strike
In such situations my preferred trade is to combine selling an in the money put with buying an out of the money call.
In this case I would sell $40 puts , then use some of the premium obtained (around 30 percent) to buy $40 calls.
The short puts allow us to participate in the profit until $40 and the long calls will give us profits if the stock moves above $40.
With the stock $4 below the strike the calls are cheap so we can control quite a few shares by just using part of the
put premium. The advantage to doing things in this manner is that if the stock fails to move above $40 and the
long call is a total loss, we still can end up with a decent profit from the short put.