Market Trends and Options Trading: Viewpoint, Probability and Implications

Abstract

Abstract In Dow theory, market trends are classified as secular trends for long-term frames, primary trends for medium-term frames, and secondary trends for short-term frames. For the long and medium terms, they can consist of major bull (bear) markets and minor bear (bull) markets; for the short terms, they may have corrections and bear rallies. These definitions of market trends are not very helpful to options traders because in practice, options trading is often done on a short-term time frame and options have a unique property of time value. Even in a bull market, there is a possibility of losing all money for buying call options; in a bear market, there is a probability of earning money for buying call options. This inconsistency often troubles options traders deeply. From the viewpoint of options trading, we introduce a new concept of analyzing the market trends and propose new methods for estimating the probabilities of the market trends since at any time the future prices are unknown. By simplifying the market trends into three concepts of uptrend, downtrend, and neutral trend, it will have consistent implications for options trading. JEL classification numbers: C13, G10, G13. Keywords: Market trends, Options trading, Trend probability, Estimation methods, Trading implications.