Stock prices move all the time. The market is efficient at pricing various stocks, but it often 'overshoots.' These situations attract many traders who wait for the price to drop and give sellers a pause. This usually causes the price to rebound, at least for the short term.
This situation, where we can predict the stock movement at a higher probability, can be integrated with options strategies to increase the expected value of the trade.
There are many ways to measure 'over sold' for a stock. Not every measure works on all stocks all the time. However, you can use Option Samurai technical analysis engine to customize your scan for oversold stocks.
Recently I saw success with RSI(14) under 30. But I usually require it to be 2-3 days at oversold territory before entering a trade (to increase the oversold).
Additionally, I will try to pair this oversold condition with an options strategy that will increase my profit or probability of profit and complement the stock movement. I usually sell puts or buy calls as these are simple strategies that I can close early or manage easily.
The bigger the stock and the higher the dividend - I would rather sell a put. The more volatile the stock, the more I would lean to buying calls.
- Oversold - A stock in oversold condition usually has a higher probability of reverting to the mean. We did a backtest to show this in our blog (RSI backtest).
- Probability of profit - If I sell OTM put, I have an even higher chance of profit and can sometimes close the trade early as the stock corrects.
- Leverage - If the stock is very volatile - I usually like to buy calls and limit my risk. This way, even if I'm wrong, my losses are capped. Furthermore - my profit potential is very high.
- Profitable companies will go up over the long run - Not every oversold stock is a good candidate. We want to trade stocks that we are bullish on.
This video is a use case we presented in a webinar. We show how to find oversold stocks to sell puts and buy calls on. You can use the predefined scans or build a scan from scratch.
See the video here: