I met Tim Bohen over a decade ago when we were both new students in Tim Sykes’ Trading Challenge.
It didn’t take long for me to realize that Bohen was one of the top traders in the class. I especially loved a certain approach he had for deciding which stocks to trade…
He calls it ‘The 3-Item Checklist’ — volume, volatile chart, and catalyst.
Let me explain. If you’re considering a setup, and…
- The volume is weak
- The chart isn’t volatile enough
- There’s no major news catalyst
…then that trade probably isn’t worth risking your hard-earned money on.
However, when you find a setup that checks these boxes — it’s time to get aggressive.
I’ve taken The 3-Item Checklist and run with it in my trading career. And it’s completely changed my trading for the better.
By focusing on stocks that check off the three items on the list, you’re setting yourself up for better potential trades.
And if you dare trade setups that don’t have at least two of the three boxes checked, you’re dooming yourself to potential losses.
Let’s break down how (and why) you should use The 3-Item Checklist in your trading…
Pump Up the Volume
First, let’s talk about volume — the total number of contracts traded on the day for that particular strike price and expiration date.
Here’s why you’ve gotta pay attention to it…
From an options trading perspective, a healthy amount of volume is important because it guarantees liquidity in the contracts.
Practically speaking, this means that when you’re ready to sell your calls or puts, there will be somebody on the other end willing to buy them.
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The last thing you want is to get caught buying contracts with little or no volume because those contracts are illiquid.
Illiquid contracts will have a large bid-ask spread. That often forces you to sell for a much lower price than you’d hoped for … if you can sell them at all.
But volume can also occasionally serve as a predictor of future price action. That’s evidenced by the countless segments on financial news media centered around ‘unusual options volume.’
If tens of thousands of weekly calls fly off the shelves day after day in a certain name … don’t be shocked if that stock goes up on Friday.
That said, there are no guarantees in trading.
Unusual call or put volume can also prove to be an attractive trap … indicative of nothing. Like anything in the stock market, approach unusual options volume with a grain of salt.
Use it as a data point to confirm or deny a thesis you’ve already developed. Don’t use it alone to locate fresh trade prospects.
Remember, you should always have a good reason to get into a trade. Never force trades!
Ride the Volatility
Volatility, on the other hand, is the most important factor in options trading. It rings the register on massive options trades.
To lock in the 100%, 200%, or even 500% gains possible on weekly options, you’ve gotta find a stock with enough volatility to make it probable.
Understand that every time you buy calls or puts, there’s a market maker (or option seller) on the other side of the trade.
They’ll do whatever they can to make sure the stock stays above or below the high-volume strike prices. That’s where implied volatility (IV) comes into play…
IV is an estimate of future volatility. As an options trader, it can either be your best friend or your worst enemy.
The higher the IV, the more expensive contracts will be. For example, the IV on momentum stocks is usually incredibly high because market makers price in the possibility of a huge swing in either direction.
The problem with buying contracts with high IV is that it will be more difficult to book large gains due to the contract’s initially higher premium…
You’ll pay more upfront. So if the stock trades sideways, you lose considerably more on contracts with high IV as compared to those with low IV.
Catch the Catalysts
Last, but not least, let’s talk about catalysts.
After volume and volatility, a strong news catalyst should be the third and final box on your trading checklist.
This one’s simple. In this news-driven market, the headlines often dictate the near-term price action.
If you understand this, you’ll realize that making any trade with a major catalyst surrounding it is better than making a trade without one.
EXAMPLE: Look at the ramp-up in Amazon.com, Inc. (NASDAQ: AMZN) shares leading into yesterday’s stock split.
AMZN was green six days in a row from May 25 to June 2, surging 20%+ in the process.
All this to say … pay close attention to the news. If you blink, you might miss a juicy catalyst that could lead to a five-star setup.
That’s all there is to it, Evolvers!
Three simple things to look for in every single setup you trade.
If you stay disciplined and always abide by the checklist, you’ll be a better trader for it. I know I am.