Using Overpriced Implosion and Underpriced Explosion
Even if you are not interested in hedging or
spreading options, you can still put the Overpriced
Implosion and Underpriced Explosion Lists to good
use.
Let’s assume you find a situation you like,
perhaps in Jeff Cooper’s or Larry Connors’
commentaries, or in one of the other sections of TradingMarkets.com, or even elsewhere, and you want to take a long position in the index, stock, or futures contract.
If that index, stock or futures underlying
happens to appear in an Underpriced Explosion List,
it’s better to select one of the five most
underpriced calls from the list than to purchase
the underlying outright. You must make certain that
the option expiration is further away than the
horizon of your trade, but since most of the
trades on TradingMarkets.com are short-term trades,
you will likely find a suitable call.
Likewise, if you wish to short the underlying
and the underlying appears on
the Underpriced Explosion List, you will do better
to purchase one of the underpriced puts than to
short the underlying. Why? Because you will gain
an additional edge from the underpricing of the
option.
If the underlying appears on the Overpriced Explosion List, you might think it wise to sell one of the overpriced puts to implement a long, or to sell one of the calls to implement a short, but this is a risky strategy that I would not recommend, as the potential loss is very high.
Taking advantage of overpriced options is a little trickier than taking advantage of underpriced options; the fact that they are overpriced makes you inclined to sell them, and selling options is always risky unless the risk is properly controlled. The right way to control the risk in selling an option is to purchase (an)other option(s) of the same kind on the same underlying, which is the topic of hedging and spreading. I will cover hedging and spreading at length in a future commentary.