I am new to options and only familiar with the basic strategies, so I am probably getting ahead of myself with this question. But how important is TA to option trading? My understanding is that to profitably trade options, you need to be able to predict their behavior which in turn is derived from the the behavior of the underlying. Therefore one must be able to correctly analyze and draw conclusions about the future movements in the underlying. One way to do this is to use the tools of technical analysis (S/R, breakouts, pullbacks, trends, consolidations, etc.). Is this correct, or it is possible to trade options profitably without even a basic understanding of the standard TA? If you do not use TA on the underlying, on what do you base your trading decisions? I am not talking about finding rare arbitrage opportunities (which are probably out of reach for the retail trader anyway) and will assume that options are fairly priced. And a corollary to this question - if one trades the underlying directionally and also options on it, will both strategies show correlation? Because most often if you are wrong on your analysis of the underlying, you should be wrong both on your directional and on your (neutral) option strategies.
If you can correctly predict the future price of the underlying, you should trade the underlying. Volatility and expected volatility determine the price of an option. You can get direction correct and loose money trading options. Get educated on options before giving away your money trading them. Buy Natenburg and Cottle's books.
Thanks HSC, but I specifically wrote the behaviour of the underlying, not the direction. What book on options would you recommend before Natenberg? I was just about to order it, but wondered if I need something more basic before that
By the "behavior" of the underlying, what exactly did you mean? Other than direction, I must assume volatility. I am not aware of any reliable TA that helps to forecast vol, although one might exist. I would start with either Natenburg or Charles Cottle. Both are excellent.
Well, on a most basic level IV increases as the price of the underlying drops sharply, and decreases on upswings. So, you can use TA to forecast IV. What I wonder is whether there are profitable option traders who just watch the options but not the underlying. Perhaps they do some statistical analysis on volatility. Anyway my question still stands...
If you believe in your first statement, then I hope you have a big account. IV is more than increase and decrease in the price of the underlying. That is only 1 component, please do a little research before you make a generality. You will not find any option trader who only looks at the TA of options, or any profitable ones anyways. derivatives are ties to the instruments, its like looking at the gas guage and predicting it rate of decline without knowing how fast or far you're driving.
So, what you are saying is that technical analysis on the underlying is essential component of an option strategy?
Of course I can't speak for everyone but to me TA and funda on the underlying is essential. remember the trend is your friend!
You have to get your edge somewhere. One way is to have a better-than-average ability to make odds on what the underlying will do. Some can do that with fundamental analysis, some can do it with technical analysis. If you don't have an edge in odds-making the underlying, you'll have to find it in the options themselves. That means you'll have to find options with distorted volatility patterns, and exploit those.