The Fearless Technician: Fibonacci & Strike Selection

Sure, option traders can choose their strategies by looking at probability, volatility, and the options greeks. But some traders like to visualize a trade before jumping in.

Looking at price charts has its benefits. First, you get an idea of the overall direction—has price been trending up, down, or sideways? With that info, you can identify potential levels of support and resistance, breakouts, and reversals. Then you can use those points to decide on your options strategies and strike prices.

Let’s walk through one charting approach that might help you make more informed options trading decisions: using Fibonacci (Fib) retracement levels.

Figure 1 displays Fib retracement levels on a chart of the E-Mini S&P futures(/ES), which is trading around $2,810. That’s close to its 50% retracement level at $2,788. Note that the retracement levels between 50% and 61.8% have acted as relatively strong support and resistance levels. Based on that information, /ES could trade within that range, but there’s also a chance it could head lower and go below the 50% retracement level or higher above the 61.8% level.

Say you’re considering selling out-of-the-money (OTM) vertical put spreads. The price needs to remain above the options strike prices if you hope to keep the full premium. So, one idea may be to consider selecting strikes below the next support level, or 38.2% retracement. That could mean giving up some premium, so weigh your risks against potential returns. And consider options with a high probability of being OTM at expiration.

Say you sell to open the put spread position and then /ES moves above the 61.8% retracement level. You could then add a call spread with strikes that are higher than the put spread.

Strike Selection

From the chart, let’s assume you determine that if /ES trades below the 50% retracement level, then $2,643 could be a possible support level. On thinkorswim, select the Analyze tab, and review the puts with strike prices below that price level.

As an example, for the put spread, you could sell the 2640 put and buy the 2635 put. And if /ES starts to move above the 61.8% retracement level, you could add a call spread with strikes closer to the 78.6% retracement level. You could consider selling the 2950 call and buying the 2955 call. It really depends on which options have a high probability of expiring OTM, and how much credit you receive versus your max loss.

The worst-case scenario? When either the two calls, or the two puts, are in the money (ITM). Remember that both spreads can’t be ITM at the same time. So, you can only lose money on one. In this case, either the calls are above $2,955 or the puts are below $2,635. Your max loss would be the difference in the strikes of the ITM puts or calls, i.e., 100 x $5 = $500, minus any collected premium and transaction costs.

Consider assignment risks too. You’ve got two spreads, and the short options can be assigned at any time.

Charts can be a great starting point for making trading decisions. They offer drawing tools and indicators you can apply to see the bigger picture. From there, narrow things down to specific strategies and strike prices. After that, it’s about how well you manage your trades.