Bollinger Bands Options Trading Strategy
You're listening, to the stock market options, trading podcast. A podcast, helping retail traders, like yourself. Get better results. If you enjoy, listening to cutting edge options, research, and trading strategies. That help you make consistent, gains in the stock market. Be sure to subscribe, now, so you don't, miss an episode. Now, here's your host. J, eric. O'rourke. Welcome back to the stock market, options training podcast, my name is eric, and in this episode, i'm going to share some research, i've been doing, around using, bollinger, bands. For trading, options, and we're going to focus, in on the russell 2000. Index. Trading, rut. Or rut. But there's something a little different with this study, than some of the other ones i've shared. And, really intrigued me so i'm excited to share this with you today but before we get started you know the deal, everything on this podcast, is for informational. Purposes, only. And this is not financial, advice. Past performance. Does not guarantee. Future performance. And options trading. May not be suitable. For, everyone. So before we get into the bollinger, band part of this episode, i want to cover just a couple things. I get asked a lot why i trade, index, options so often. And there's a few different reasons but i want to talk a little bit about the main reason. Why i trade index options i usually trade spx, mostly, but, i'm trying to, incorporate. Rut more which is sort of a. Premise for this episode. But the biggest reason, i like to trade index, options. Is that. There's no risk, of early, assignment. In fact there's actually no risk of assignment, at all because, both spx, and run there's other indexes but those are the ones we're talking about. They are cash settled, indexes. Meaning. Even if you let the options expire in the money. You're not going to end up with stock in your account they'll just figure out the difference of whether you made money or you didn't make money. And you just end up with cash or negative cash if it's a loss in your account so i like that aspect. But the risk of early assignments, really really, important because when you're trading. Uh weekly, options. And you're you're trading something that goes in the money let's say a credit spread where you have a short strike. Option. That goes in the money. If it's the last week's expiration. And it's really in the money you could be assigned, that stock if you're not trading. An index, option so i really like. The, uh, the, not having the the, risk of early assignment. Uh which is why i trade so many. Uh index options there's also some other benefits, i definitely, encourage you to google. This type of information, to get a better understanding, on your own. Um you can look up, american, style. Options, or expiration, versus, european. Style. And that will help you get a better understanding, of that. Let me throw one more thing in there about about the early assignment. Uh when you're trading, short term options, that are one two three weeks out that's what we're going to talk about in this episode. Um. The math, actually. Starts to play out, um in my opinion and what that what i mean by that the probabilities. Play out. And. The way, you know you can kind of see this is if you're, if your option is. You know let's say you sell. A. Credit spread which is what we're going to talk about. And that short strike is in the money. You may be inclined. To close, that trade, normally, because you don't want that risk of assignment. But what, what you're doing by closing the trade early. Is not allowing, the probabilities. To play out, now there are plenty of reasons why you may want to close the trade early take profits. Uh that that type of thing but if you're right on the edge. You're you're, you know you can cut your trade short, and not let your. The probabilities. Play out so that's just one more thing i wanted to add in there about. The early assignment, risk.
So Again with index options you don't have to worry about any of that stuff you can just focus on the trading. And again, look it up google it, take some responsibility. For your own account with your own money, and really get yourself educated, so. So real quick. I posted an article. With some of the visuals. About, the the strategy. And performance, that we're going to talk about, it's over on my patreon, page or patreon, website which is patreon.com. Forward, slash, vertical, spread, options. Trading. And i'm also gonna put a link in the description. And the show notes so if you wanna. Go check out the visuals that that go along with that that's available to all the podcast supporters. Um so let's talk about bollinger bands real quick i'm not gonna dive into everything about them most people know what they are, but real quick they're they're kind of a volatility. Indicator. They create upper and lower bands. Around, the price. And it's typically. Based on some level of standard deviation, the the. Out-of-the-box. Bollinger, bands on most platforms. Goes back, a 20-period. Look back, with a two standard deviation, and that's what we're going to be using. For this study. And there's a couple schools of thought on how to use them and they really are are like the exact opposite, so. I'm not here to tell you which one's better, i'm just kind of, uh letting you know how people use them, that i've seen. What i'm more inclined to and then what the the actual research. Um, kind of showed so. So for this particular, study we're going to get real. Specific. We're going to be focusing. On. The. Uh, just the upper band. If the stock in this case the rut or the iwm. Is the the etf, but we're going to talk about the rut. If you get a close. Above the upper band. That's what we're going to be focused on that particular. I'm going to call it a, trade entry or trade signal. Or some kind of, significance. In the market we're going to identify. A close, above. The, upper bollinger, band as a significant. Event. And base everything off of that there's a couple things here so. When the market closes above the upper band this is actually. Um, you know indicates, a level of bullishness, because price has closed. Above, two standard deviations. Of, you know recent price action in the last you know 20 days so, the first school of thought. And, this is what, i've, you know read more in the trend falling, world, which i do trend following as well. Um, the trend following. World, they often can see this as sort of a breakout, to the upside. And. It could be a sign of bullishness. Which obviously it is, and that possibly, a new bull trend may be taking place, so they're going to look at this close above the upper band. As a, way to potentially, get bullish i'm definitely not saying. You should, buy anything, on a close above the band but, it just indicates, the bullishness, there's other things to kind of confirm, that if you will. The second school of thought is sort of the contrarian. View and this is kind of where i've always sort of ended up. Where if the market. Whatever stock or whatever you're looking at if the market. Rallies. Really hard. It's going to close above that band, and i'm a little bit more on the contrarian. Side saying hey, too far. Too fast. And. We could look at a contrarian. Trade to either fade that with the idea that, the market may pull back a little bit, one of the stats that gets thrown, um, around a lot is. Something, like. 95. Of. Of, price closes. Should close. Within, the bands like between, the two bands. This is can be sometimes, deceiving, because the bands. Are are often, sloping. Up and down, when you get a volatility. Move in either direction, so. Just because. The price, is closing above the band. Doesn't mean the price is necessarily going to pull back because the band's going to move higher too so if it trades sideways.
You Could get a close inside the band so it's not always a straight like okay this thing's gonna. You know quote unquote reverse. Uh, however. It does indicate, that, uh to me that you're kind of in a, overbought, situation, so those are kind of the the two schools of thought one is. People want to look at that as bullishness, and maybe find a way to get along. Others think it's. Uh more of a contrarian, and they're looking for ways to sort of get short for a pullback that kind of thing but probably more of a fade. If you will. So this um, trading, signal, the close. Above. The upper band, is, sort of the foundation. Of this strategy. And, i chose to focus, on, the, spx, and rut because i really wanted to. Combine. The. Higher probability. Of credit spreads. With. This particular, move because it's not it doesn't happen all the time. And we'll talk about the results, and how many um, trades, were issued if you will over the past, we're gonna get a five year look back. Um and it's not a ton you know it's not like every week you're going to get this move so, i wanted to factor, in, um some credit spreads, because you can position, those to be higher probability, you can, you can position them to be, certain duration, so we'll talk about that in a minute, uh we're gonna be looking at five years. Going back as i mentioned. And, there's two things that, that when you start back testing, especially with options and stuff there's really, two main things that i sort of focus on, one is the time to expiration. Is, you know the the number of days to expiration. And, i'm sure there's tons of stuff on the internet, i know in the tasty trade. World they talk about 45, days for credit spreads. For monthly spreads. That's great. This one we're going to be looking at shorter, term. Moves something less than 30 days. So time to expiration, is very important. And then the other aspect, is the distance. From, the price. So, how far away, is the option, you are, selling, if you we're going to be selling credit spreads here, for this study, how far away are you how, and i'm air quoting how safe are you and and what you probably know by now if you followed my stuff, before, is, just because you're really far away from the money doesn't necessarily, mean it's safer. Because you're not going to make as much money. Um, with the safer you are and then the one big one, that goes against you you can wipe out all your gains so it's not necessarily, the best idea to go, super far out of the money, but it's also maybe not the best idea to go right at the money either because the probabilities, are less so we're gonna explore, that a little bit, here with the um, with a back test, so the way that we're going to, measure, the distance, aspect of this. Is by looking, at the delta. Of the option so we're going to we're going to focus, our. Distance, based on the short strike the short strike, of a credit spread.
Is The option that's closest to the money and then you you buy the outer option whether it's a call or put spread. You would sell one option and you buy one, farther away depending on it's the the top, or bottom. So we're looking at delta, as a. Way to measure distance, from price. Now if you're new to options. You've probably read a book. That tells you that delta, is the amount. The price of the option will move if the stock moves one dollar, right, which is totally true, but the way we're going to use it is to measure the distance like i said. And it also sort of tells you, um. Sort of a probability. Of that, option expiring, in the money so here's here's what i mean. If you look at a delta 50 option just open up whatever stock you want. Open up the option chain. If you find the delta 50, option you're going to find that that option whether it's a call or put. Is going to be really close to where the stock is is trading, right, it's right in the middle. Um, and. Basically what that's telling you is is. Yes. If the stock moves a dollar. The delta 50s, you're going to you know. Win or lose 50 cents, for that particular, option. But it also tells you the chance of that option expiring, the money, so if the option is trading, right at the same i'm sorry if the stock is trading, right at the strike, price, and it's a delta 50. There's about a 50. Chance that that thing expires, in the money and it doesn't even really matter. The expiration. Uh, so the same thing is true if you look at an option that's let's let's say it's a delta 30, and let's say we're looking at a delta 30 call option, a delta 30 call option, is going to be a certain, distance. Above. The price. So the probability, that that, call option expires, in the money is less because the stock has to move up a certain amount to get above that. So the loose probability. Of a delta 30 option. It means that. There's a 30. Chance. That it expires, in the money, and the way you can read that is a 70. Chance that it expires, out of the money, and that's where the probability, of selling options come in and just to be clear this is not an exact, probability. It's it's a close probability, if you look in and i use thinkorswim. You can bring up the probability, of in the money and it's pretty close to the delta so, it's i so i term it as kind of a loose probability. So, we're going to be looking at that distance, we'll look at different distances. We're going to end up around delta 30 in most cases but um not always. And, that's where we're going to be choosing, to. You know where we're going to place, our credit spread so we're going to look at time. How. How many days to expiration. And i like to use the term dte. Days to expiration. We're going to look at 7 days 14, days 21 days 28, days. So one week two week three four weeks to expiration. With different distances. To see. Uh. Which ones worked better. When. The, russell 2000, closed, above. That upper bollinger band, and real quick i knew that was a bunch of option, information, that i i just went over. Um, but if you're new and you're a podcast, supporter, feel free to message me in the mobile app the patreon mobile app you can message me directly. With any option, or or, trading questions and i can get back to you, so feel free to you know if you want to take that conversation, offline. Get get with me and i'll get back to you um, as, soon as i can so, all right so now we have a base understanding, of what we're kind of researching, here what we're talking about, let's talk about the bollinger, band, so let's just clarify. The, actual. Entry signal, so on any particular, day. If the closing, price, of the rut rut, is below, the upper band. Then, the next day the closing, price of rut, closes. Above the upper band, that is the signal it's a closing. Uh it's a cross, above, the upper band on a closing. Basis that's it that's the signal. So when i was first kind of running this through the software, the first thing i noticed. Was, is, you know i was kind of looking at spx, android. The first thing i noticed is that. What worked for the spx. Did not work for the rut it wasn't, they weren't in line which was, not, completely, unsurprising.
I Thought they'd be a little bit more correlated, but. Um, but in general the you know with the varying. Distances. And the varying, days to expiration. Spx. Tended, to work better to the long side. And remember that's kind of what the first school of thought that that the close above the upper band is sort of a bullish, indication, right. But the rut, actually worked better. In general not always, to the short side so that's kind of in the second. Kind of uh school of thought with with that upper band closed so. Now it kind of makes sense because, often, the russell 2000. Often will underperform. The s p 500. Because russell 2000, is is more american, companies, small mid-side american, companies. A lot of banks in that by the way maybe that's why i don't know, uh and yes. S p 500, is you know the the largest corporations. Some of them are many of them are global, and sometimes, some of them are safe havens you got apple and big tech in there and and that can um, kind of sway the index a little bit so. Um but in general, the s p 500. Tends to output. Perform. The russell, over time not in all, you know periods of time but but in general right so. So so here's the first takeaway before we even get to any of the stats, the first takeaway, here is that, what works on one index. Does not necessarily, mean, it's going to be universal. Across, all stocks and all other things so, we're really, kind of. Narrowing, down to, how a particular. In this case index, trades. And that's what we're going to kind of. Focus on now i kind of had this idea that there could be a pairs trade here where. You know you could go. Long spx, and short rut when that, that, bollinger band signal happened that's something i'm going to keep exploring, but i didn't get to it for this one i wanted to share, you know just kind of the rut so. We're going to focus in on the rut. Um for the bollinger band breakout strategy, and you know kind of the rest of uh this episode. All right so the first. Trade we're going to look at when the rut. Crosses, above. The upper bollinger, band. Is we're gonna look at a, seven days to expiration. Seven dte. Delta, 30 put credit spread. Where you're buying, the next strikeout, so that means. That when that trade happened the software is going to find. Uh the next expiration. That's about seven days away. Nothing's, exact it could be six it could be eight. Remember. Uh, rut. Spx, these have weekly, options. So there's a little bit more choices in there, and. The. Uh. The put credit spread where we're going to look at the bullish, strategy. Um actually did pretty well so the seven day put credit spread that's at about delta 30. Um, did pretty well, and by pretty well there were a total of in the past five years 33. Trades. The win rate was about 85. And the total, return, was about 1200, just over 1200. For trading. A single, uh a single. Strike. Credit spread, so. Uh when you think about that a single strike credit spread that's five dollars wide is is about 500.
To Trade that one spread. So this more than doubled your money just trading, the bull side for a seven day to expiration. So that was pretty good, the rest of the trades, we look at 14, days, 21, days. And 28 days are all going to be bear call spreads. And this is something that i'm kind of you know starting to think about it's like well what if you just did all of them what if you just said hey this trigger happened so i'm going to put all this trade on, so you're a little bit more balanced so that's something i'm kind of, you know been thinking about when i look at some of the results, let's go through the. Day. Credit spread this time it's a delta 30, call spread. Had 29, trades. Made a total of 2 400. And this, could be one or two strikes. So it varies a little bit but. But again did very very well more than doubled your money trading the 14, day. Call spread. Then there was the 21, day call spread this thread was a little bit different the ones that best, that performed best, wasn't necessarily, farther away it was actually a little bit closer it was a delta, 40, and when you look at that on the chart a delta 40 is only you know a couple strikes away, typically. From price so it's a little bit i don't call it at the money but it's a little bit closer. Uh to at the money. It made about 2500. Over the five-year period again about 29, trades. And the last spread we're going to look at, is the 28-day. Delta, 30 call spread so we're going back to delta 30 this time 28, days to expiration. And, again. This actually had less trades which kind of makes sense because. At 20, uh 25, trades, it's a little bit less because sometimes you can get multiple, triggers. And the software isn't going gonna, take an additional, overlapping, trade so you may get more trades with the seven-day, spread versus the 28-day, spread and that's what we're seeing here, we had 25, trades over the past five years again not a ton of trades. But, very profitable, made over two thousand dollars, over twenty three hundred dollars, actually, which is actually like. Three or four hundred percent, on your money. During that time period. So again this isn't a, consistent. Strategy. In the sense of. I'm gonna trade this every week it's more situational. But it's a consistent. Strategy. With these varying. Option. Spreads, and types it's a consistent, strategy. For that particular, trigger which again is the market. In this case the rut crossing, above. That, uh upper bollinger, band so, um i really, think it might be easier for you to understand. And see the results, over on the website, so be sure to check the description. For these, sort of uh supplemental, posts where you can see the results there's a few more, uh details, then there again you can find that over on patreon.com. Forward slash vertical spread options trading. Again my name is eric i hope you enjoyed this episode. Feel free to share this subscribe. And let me know what you think and we'll see at the next episode. Thanks for listening to the stock market, options trading podcast. To join our community, of options, traders, head on over to patreon.com. Forward slash, vertical, spread, options, trading, for details. But before you go, you should know that everything discussed, on this podcast. And in this episode, is for informational, purposes, only. And should not be considered, financial, advice, of any kind.