Option Trading With Elliott Wave

HOW TO USE
THE ELLIOTT WAVE PRINCIPLE

TO IMPROVE YOUR
OPTIONS TRADING STRATEGIES
COURSE 1:
Vertical Spreads
EWI eBook
How to Use the Elliott Wave Principle to Improve Your

Options Trading Strategies
Course 1: Vertical Spreads
By Wayne Gorman, Elliott Wave International
Chapter 1 Bull Call Spread and Bear Put Spread
Chapter 2 Bull Call Ladder and Bear Put Ladder
Chapter 3 Ratio Call Spread and Ratio Put Spread
Chapter 4 Bear Call Ladder and Bull Put Ladder
Chapter 5 Call Ratio Backspread and Put Ratio Backspread
Chapter 6 Questions and Answers
Introduction
This eBook introduces the standard textbook definitions of various options strategies and then explains how to
apply them in the context of Elliott wave analysis, using real-world price charts. My name is Wayne Gorman,
and I am Senior Tutorial Instructor at Elliott Wave International. I have over 25 years of experience using the
Wave Principle in trading, forecasting, and portfolio management.
Every point of discussion in this course falls under the umbrella of vertical spreads. These are option strategies that are either all calls or all puts, with the same expiration date. The term vertical implies a sharp price
movement in either direction. (Range-bound vertical spread strategies apply to sideways price action and
are not covered in this course.) For this course, I chose five different vertical spread strategies and paired them
with their bullish and bearish counterparts.
Before we get to the material, Id like to make two important points. First, the intent of this course is not necessarily to recommend using one or more of these particular strategies. The purpose is to teach how to formulate
and execute these strategies by using the Elliott Wave Principle. And second, Im not going to try to show
whether these strategies are better or worse than going outright long or short in futures or cash. We will just
deal with these option strategies on their own and look at how the Wave Principle helps us in terms of setting
strikes, establishing expirations and managing the strategy from start to finish.
Editors note: This webinar was originally presented live on August 28, 2008.
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2009 Elliott Wave International
Chapter 1
Bull Call Spread and Bear Put Spread
1.
Bull Call Spread
Buy 1 ATM Call
Sell 1 OTM Call
Net Debit
Moderately Bullish
Relatively Longer-Term Strategy, 3 to 6 Months
Maximum Risk Capped at Net Debit
Maximum Reward Capped at Strike Difference - Net Debit
Breakeven: Long Call Strike Price + Net Debit
Figure 1
The first strategy that we will look at is the bull call spread. To start with, Ill give the standard definition
seen in most options books or websites, as underscored by the abstract above: A longer-term strategy that lasts
three to six months, this spread involves buying an at-the-money (ATM) call, and selling an out-of-the-money
(OTM) call, resulting in a net debit. Time is of the essence. Maximum risk is capped at the net debit, and
maximum reward is capped at the difference in strikes less the net debit. We have one break-even level the
long call strike plus the net debit. As we go along, we may deviate from this ideal with respect to the time until
expiration, based on Elliott wave analysis (of course, for positive reasons, not for negative ones).
2.
Bear Put Spread
Buy 1 ATM Put
Sell 1 OTM Put
Net Debit
Moderately Bearish
Maximum Risk Capped at Net Debit
Maximum Reward Capped at Strike Difference - Net Debit
Breakeven: Long Put Strike Price - Net Debit
Figure 2
The bearish counterpart is the bear put spread same type of structure, except this time youre betting on
a decline in prices. The thumbnail sketch above fills in the rest: Buy an at-the-money put and sell an out-ofthe-money put, resulting in a net debit. Maximum risk is capped at the net debit. And maximum reward is,
again, equal to the difference in the two strikes less the net debit. The breakeven is the long put strike price
less the net debit.
There is one key consideration regarding these strategies they involve limited moves. By selling the put or
call at a strike thats further out of the money, we technically give up certain profit potential. However, since
were predicting that the move is limited, were not really giving up anything, all the while reducing cost.
Figure 3
Now, lets look at these strategies from an Elliott wave perspective. This table features the optimal Elliott wave
attributes for using the bull call spread and bear put spread key word being optimal. You could use these
strategies in other situations; these scenarios simply provide an ideal context. The left-hand column names six
categories of wave type. And the right-hand side, their corresponding characteristics.
Before we get to an actual trade setup, we must first examine the lists individual parts: wave function, position, structure, degree, entry point, and prior wave at next lower degree.
Function: From an Elliott wave standpoint, vertical spreads are best suited for limited moves such as those associated with reactionary or countertrend moves. What does that mean in terms of wave position? This would be
the second and fourth waves within an impulse wave; a B wave within a zigzag, a flat or a triangle; the D wave
of a triangle; and the X wave in a double zigzag, triple zigzag, or double-three, triple-three combination.
Again, why are these wave positions good for these strategies? Theyre limited. These countertrend moves can
go only so far. Wave two always retraces less than 100% of wave one. Wave four can never end in the price
territory of wave one. A B wave in a zigzag can never go beyond the start of wave A. And wave D in a
contracting triangle cant go beyond the previous wave B. On your X wave, however, the limitations are in
terms of guidelines, not rules: the B wave in a flat could go beyond the start of A, and in some combinations
the X wave could go beyond the start of wave W or wave Y.
The best structure for these strategies is a zigzag, because were looking for a sharp move. The ideal situation would be for the price of the underlying asset to go right to the strike price of the out-of-the-money call
or put that we sold, right at the expiration date. But certainly, its better to have purchased more time than we
need than to run out of time.
Preferably, the zigzag would occur at a fairly low degree. Why do I say that? This is because were looking for
relatively small moves here. Weve limited our profit potential. Weve limited our upside potential. Its hard
to put an exact wave label in terms of Minor, Minute or Primary, because those can vary. But at the extremes,
were not looking for Cycle or Supercycle degree with these strategies. We want to enter these strategies early
in the wave position. Again, time is of the essence. Were buying basically at-the-money. We want to get in as
soon as possible to take advantage of this move.
Finally, you need evidence that strongly suggests the entry point will precede a turn. For example: Before you
go into a wave two or four, it would be ideal to see the previous wave at one lesser degree (i.e. the final leg
of the preceding wave one or three) unfold as an ending diagonal, a truncated fifth, or a fifth wave extension
all patterns that imply an immediate and swift reversal in trend. If you dont see any of these game-changers
in the previous wave at one lesser degree, then you have to spot some other indication of change. This could
be a reversal on the weekly bar chart or a completed five waves in the fifth wave. Whatever the scenario, there
should be some evidence of a trend change before you can enter into the position.
The one rule that is essential to applying this strategy and all the others in this eBook is this: Always rely on
Elliott wave rules and guidelines.
Now its time to see an example of how to use these strategies on an actual price chart.
Figure 4
This is a futures weekly continuation bar
chart of the euro against the U.S. dollar
from 2005 to 2008. Ive labeled the chart
starting from the November 18, 2005,
weekly low at $1.1661. From there, Ive
counted completed Intermediate waves
(1) and (2), and a partial Intermediate
wave (3). Intermediate wave (3) subdivides into Minor waves 1 and 2 (in
red) and Minor wave 3 (not labeled on
chart) subdivides into Minute waves 6
through 9 (circled in brown).
That leaves us with an open ticket into
Minute wave 0, so lets blow up that
leg of the advance.
Figure 5
Were going to start trading on April
23, 2008, the last bar on the daily chart.
This will be our entry point.
Figure 6
Now Ive attached some wave labels,
and you can see we have a decisive
move up in Minuette waves (i), (ii),
and (iii) (in blue). Within Minuette
wave (iii), Im counting Subminuette
waves i through v (in red) as one
probable scenario. This brings us to
the exciting part: Subminuette wave
v contains five overlapping waves
(circled numbers) with a wedge shape,
the classic trait of a fifth-wave ending
diagonal. This is an exciting event,
because fifth-wave diagonals qualify
as one of the key patterns that signal
a swift and sharp reversal ahead. And,
according to Elliott wave guidelines,
the reversal will end at least where the
diagonal began. In this case, that area
is marked by the start of Subminuette
wave iv (in red).
Figure 7
So, what are we looking for? A sharp
albeit limited decline for Minuette
wave (iv) back to at least the start of
the diagonal, and maybe even further
beyond that. What if were wrong?
Are there other possibilities? Yes, the
ending fifth-wave diagonal scenario
may instead be waves A and B of some
type of flat structure. Even so, in a
flat, wave C should still come down
to where wave B began a similar
target zone as the diagonal scenario.
In either case, the larger implication is
the same a move down. The one difference is time. If an ending diagonal
is at hand, the decline will be swift; if
its a flat structure, the drop may take
longer to unfold.
Figure 8
Another way to determine how far
wave (iv) may go is to look at the
market from a Fibonacci retracement
point of view. Keep in mind that fourth
waves are normally shallow and make
.382 retracements. You can see in
Figure 8 that the .382 area lands at
$1.5362, within winking distance of
the level where the diagonal began
$1.5273. Pretty close. Of course, wave
(iv) could go further, in which case
Ive also labeled the three common
runner-ups for Fibonacci retracement
levels: .500, .618, and .786. However,
since fourth waves can never end in
the price territory of first waves, we
can eliminate the .786 scenario.
Figure 9
On this chart, drawing a trend channel doesnt help in terms of price, but
it does offer us a guide in terms of
time. Figure 9 calls attention to the
fact that were looking for a move that
could happen fairly soon. Therefore,
we dont have to go out too far with
respect to option expiration dates.
We dont have to go out six months,
or even three months, to realize the
same move. Keep in mind, we want
to maximize yield or return on capital.
The less money we spend by being
able to select a shorter time period for
our expiration date, the greater our
return on capital will be if we can still
achieve the same move within that
time period.
Figure 10
Ideally, well hit the nail on the head
here. However, Elliott wave analysis
is about probabilities, which are never
accurate 100% of the time. So, the
last thing we need to do is prepare for
a Plan B exit strategy, in case were
wrong and the euro goes up. In Figure
10, I use the Fibonacci guideline of
expansion for fifth waves to determine
where one should get out to salvage
this trade. According to this guideline,
one possible scenario is wave five will
be equal to .618 times the net distance
traveled of waves one through three.
And that comes up to $1.6230. So, if
prices do go the opposite way and we
have a net debit, thats the one level to
keep in mind to unwind the trade and
recover whatever we can in terms of
premium.
Figure 11
Another useful guideline of Fibonacci analysis states that wave four
often divides an entire impulse wave
into either the Golden Section or two
equal parts. On the chart, you can see
that theres a Golden Section if Subminuette wave v (red) ends at $1.5840.
(Weve already gone past that level.)
The 50% divider comes out to $1.6191.
So, if were wrong, this offers another
possible area for wave v to travel. In
terms of unwinding these trades, well
look around that $1.6200 level to warrant getting out of these positions.
Figure 12
So, now that we have all the pieces in
place, lets examine the big picture.
Were going to do a bear put spread
on April 23 (recall Figure 5). On that
day, the price high was $1.5964, the
low $1.5826, and the close $1.5854.
Please Note: All of the option prices
that Im showing are closes.
On our entry point of April 23, were
buying an at-the-money June $1.5850
put at .0228. The June puts expire
on June 6th, so were keeping this
short, just about a month and a half.
Next, were going to sell an out-ofthe-money June $1.5250 put at .0054.
And why did I pick $1.5250? Thats
our previously determined target from
Figure 8, which is close to where the
diagonal began at $1.5273. So, were going to look for a move to that level over the next month and a half.
We end up with a net debit of 174 points, so our maximum risk is .0174; our maximum reward is .0426; and
our breakeven comes out to $1.5676. Im also showing the implied volatility at the time on the front contract
June. Im not going to get into any analysis on implied volatility in this particular course. This is purely a
directional price movement strategy.
To review: Were going to look to unwind the trade when we get to $1.5273 and, hopefully, thatll happen
right at expiration. If things go the other way, were going to look to get out and salvage something at $1.6235,
based on those Fibonacci calculations
for wave five.
Figure 13
In Figure 13, we flash forward to see
how the trade unfolded. The fifth-wave
ending diagonal did indeed deliver a
swift reversal (recall Figure 6). And,
as you can see, we reached our target
of $1.5273 on May 8th. From a risk
point of view, there is no reason to
stay in this position so were going to
unwind the trade and close out on May
8th. Well sell the June $1.5850 puts
at .0508; well buy back the $1.5250
puts at .0123. We get a net credit of 385
points and a net profit of 211 points.
Implied volatility did not change much
it was 10.3% (versus 10.6% on
April 23), so that worked in our favor. The secret to the trades success was its adherence to the ideal wave
characteristics of a bear put spread strategy as identified in Figure 3. It was a countertrend move in a fourth
wave of low degree (Minuette). We entered early. And, most importantly, the key to setting up everything was
identifying that we had a fifth-wave ending diagonal in the prior wave at the next lower degree. As we know,
this pattern implies a dramatic reversal ahead.
Figure 14
So, we got out on May 8th, but the
contract didnt expire until June 6th.
In Figure 14, you can see that our
choice to exit early was the right one
in order to satisfy the risk/reward
ratio. We made a slight new high in
Minuette wave (v) at $1.5988. (The
previous high in Minuette wave (iii)
was $1.5985.) This move unfolded as
another fifth-wave ending diagonal,
which, sure enough, was followed
by a swift and sharp reversal to the
downside.
10
Chapter 2
Bull Call Ladder and Bear Put Ladder
1.
Bull Call Ladder (Long Call Ladder)
Buy 1 ATM Call
Sell 1 OTM Call
Sell 1 Further OTM Call
Net Debit
Moderately Bullish
Relatively Shorter-Term Strategy, 1 Month
Maximum Risk is Uncapped
Maximum Reward Capped at Middle Strike - Lower Strike - Net Debit
Breakeven: Long Strike + Net Debit
Breakeven: Total of Short Strikes - Long Strike - Net Debit
Figure 15
The next strategy is the bull call ladder, sometimes referred to as the long call ladder. (And of course its
counterpart, the bear put ladder.) Figure 15 lists the major aspects of this strategy: We buy an at-the-money
call (or an in-the-money call), sell an out-of-the-money call, and sell a further out-of-the-money call. This
is a moderately bullish, short-term (about one month) approach that produces a net debit. Maximum risk is
uncapped. We have an uncovered option with the further OTM short call. The maximum reward that we can
make is the difference between the middle strike and the lower strike, less the net debit. And, we have two
breakevens: The long strike plus the net debit, and then, the total of the short strikes minus the long strike minus the net debit. Initially, as prices rise, well break even just by moving up to cover the net debit. Of course,
our maximum profit will be at the first OTM short call strike, and we come up to our next breakeven after the
second OTM short call strike, after which point we begin to lose money.
I want to say a few things about uncapped risk, because there are two pairs of strategies in this course that
have uncapped risk: the bull call ladder and bear put ladder, and the ratio call spread and ratio put spread. This
is not academic. This is real and true. In options, the notion of a stop loss is not as safe as it is with futures.
If you want to exit a position at a certain level, either where the price of the underlying asset is trading or at
a certain premium, you can put an order into a broker. However, theres no guarantee that youre going to get
out on a dime. As a matter of fact, if its a fast-moving market, you may not even get a quote in options. And
so, Im not going to use the term stop-loss order with options because its misleading. It implies that you can
achieve some type of immediate liquidation at a specific price point, but you really cant.
11
On paper, this strategy is akin to an extension of the bull call spread. Were getting a little bit more income on
the second short call, and were creating a second higher breakeven for ourselves. Were also keeping the strategy short-term, because with uncapped risk we dont want to allow for too much time. And, of course, with the
bear put ladder, we have the same type of structure except that were betting on prices to decline (see Figure 16)
2.
Bear Put Ladder (Long Put Ladder)
Buy 1 ATM Put
Sell 1 OTM Put
Sell 1 Further OTM Put
Net Debit
Moderately Bearish
Maximum Risk Uncapped
Maximum Reward Capped at Higher Strike - Middle Strike - Net Debit
Breakeven: Long Strike Price - Net Debit
Breakeven: Total of Short Strikes - Long Strike - Net Debit
Figure 16
Figure 17
So, what are the optimal Elliott wave characteristics for a bull call ladder and a bear put ladder? Well, again,
were talking about a countertrend move. We have limited profit potential, and, of course, we have uncapped
risk. Wave position is exactly the same as the previous pair of structures: Waves 2, 4, B, D, and X, and were
12
looking for a zigzag. We want to get this over quickly and get out. We want a sharp move. We want to enter
in the middle stages of those wave positions, either Wave C of 2 or Wave Y of 2, for example, because we
dont have much time to work with. And of course, the pice de rsistance a provocative wave prior at next
lower degree: i.e. an ending diagonal, truncated fifth or fifth-wave extension that will lead to a swift and sharp
reversal. The final point cant be overstated: Always rely on Elliott wave rules and guidelines. In particular,
wave 2 always retraces less than 100% of wave 1; wave 4 can never end in the price territory of wave 1; and
wave B of a zigzag can never go beyond the start of wave A.
Once more, Im not necessarily recommending that you all go out and use this strategy. Its a strategy that some
people employ. But if youre going to go there, you might as well know how to improve it by using Elliott
wave analysis.
Figure 18
Now, lets look at an example. Figure
18 is an Elliott wave-labeled chart of
the NASDAQ 100 from October 2007
to March 2008. As you can see, we
have completed Minor waves 1, 2, 3,
4, and 5 (red) of Intermediate wave (1)
(blue). Within Minor wave 5, we see a
familiar formation: a fifth-wave ending
diagonal (the same pattern we saw in
Figure 4 of the euro/U.S. dollar). As
we already learned, ending diagonals
are one of three patterns that precede a
dramatic reversal. The other significant
development is a gap up from March
17th to March 18th, after the culmination of the ending diagonal. If we were
doing an outright long futures trade,
this area (in and around March 17)
would represent the most promising entry point. Keep in mind, however, that during this part of the lesson,
we are not going to simulate all trading possibilities. Well wait until we reach the proper juncture to do a bull
call ladder or bear put ladder.
Based on what we know about ending diagonals, the next likely move will be up and sharp. The option strategy
of choice is a bull call spread; this time, in the opposite direction of what we did on the euro. And the outside
target is where the diagonal began, which is at 1,876.75, the end of Minor wave 4. Lets see what happens.
13
Figure 19
Figure 19 shows that we did, in fact,
make a swift reversal back to (and even
beyond) where the diagonal began.
The move unfolded as Minute waves
6 through 0 of Minor wave A (red) of
Intermediate wave (2) (blue). Had we
done a bull call spread, the trade would
have been a success. Assume that we
got the move, did the bull call spread
and we got out. Now what?
Unless our wave count is totally
wrong, Intermediate wave (2) is now
under way. We have a countertrend
move of small degree. We know that
wave 2 always retraces less than 100%
of wave 1, which would help to deal
with uncapped risk situations. Ultimately, the setup is ideal for a bull call
ladder. We want to earn some premium on the uncovered short call, but we also want a good amount of distance
between our entry point and the second breakeven. Hopefully, in this case, our upper limit or breakeven will
be in the area where wave (2) can never go. If we enter the bull call ladder too low relative to the expected
move, our second breakeven will be within range of wave (2), and we could lose money. If we sold an out-ofthe-money call much further up to avoid losing money, we wouldnt get much premium for it at all. We have
to find a compromise between these two objectives. So, we have to do the bull call ladder at least in the middle
of the anticipated upward price move. The anticipation is, of course, for a Minor wave B down followed by
Minor wave C up.
Figure 20
Figure 20 shows that Minor wave A
within wave (2) has retraced .382 of
Intermediate wave (1) at 1,894 (the
exact .382 level was 1,893.25). This
is important, because second waves
do NOT make shallow retracements.
They generally carve out much deeper
ground, such as .500, .618, .786 and so
on, as high as possible while staying
below the start of wave one. So were
going to plan for the C wave within
wave (2), and were going to look for a
much deeper retracement. Ive added a
Fibonacci table to the chart to identify
the potential upside targets for Minor
wave C. So, lets move ahead.
14
Figure 21
Ive labeled the ensuing price action
Minor wave B. It made about a 50%
retracement of wave A. Weve also
gapped up, which could be the start
of wave C. But, we need to be certain. There are a couple of guidelines
we can use here to lead us forward.
First, Minor waves A and B look to
be forming a zigzag; this is a simple
three-wave pattern labeled a-b-c in
which the subdivisions are 5-3-5. And,
in a zigzag, the most common relationship for wave C is that wave C equals
wave A. Another guideline is that wave
C may also equal 1.618 times wave
A. In this case, Minor wave C equals
Minor wave A at 2,006.50. The .618
is 2,032 very close. Minor wave C
equals 1.618 times wave A at 2,145.50. So, we will eliminate the higher Fibonacci retracement level of .786
(at 2,130.50) and 1.618 times the length of wave A (at 2,145) and turn our eyes down to the 2,000-2,032 area
for a likely target, because we have a Fibonacci cluster there.
Figure 22
Based on our analysis, were going
to do a bull call ladder on April 16,
2008. Remember that I am using
closing option prices specifically.
On April 16, the futures price closed
at 1,862.50. So, were going to buy a
slightly in-the-money June 1850 call
at 84 points. Were going to sell an
out-of-the-money June 2010 call at
18.50 points right around the area
where Minor wave C equals A, and
close to the .618 retracement level.
This is where we expect wave (2) to
end. The June contract expires on June
20, 2008.
As you can see in Figure 22, there is
also a short out-of-the-money June
2050 call at 11 points. The purpose
of this second short call is to produce
more income with manageable risk. The result is a second breakeven that is beyond the .786 retracement of
2,130.50. (.786 is about the maximum retracement for second waves, but it is possible for second waves to
15
experience a 99% retracement.) So, the goal is to get a decent amount of premium that reduces the net debit,
and create a high second breakeven level that provides a cushion against that uncovered short call, in case
prices go past the 2,050 area where were exposed.
I have a net debit of 54.50 points. My maximum risk is still uncapped: Maximum risk on a down move is 54.50
points, on an up move its uncapped, and maximum reward is 105.50 points. The lower breakeven is 1,904.50.
The upper breakeven is 2,155.50, which is based on the gain the strategy would make between the buy call
and first sell call as prices move up, less the net debit. That breakeven is also beyond the .786 retracement
of 2,130.50, an area where wave (2) is unlikely to go. Ideally, if its a fast-moving market and prices abruptly
skyrocket or plunge, I would call my broker to exit at 2,010 or unwind at 1,780. But, if he cant get me out, I
still know that after 2,010, there are 145 more points of upward movement before the market reaches 2,155
and thats just breakeven. A move below 1,781.50, the low of Minor wave B, would negate the wave count,
and I would look to close out the position. Footnote: I selected these particular strikes based on the Elliott wave
analysis and the market premiums that were available. In the end, after doing several calculations, they were
the best I could do for this trade. Implied volatility is 24.6%.
Figure 23
In Figure 23, you can see that we did
indeed move up in what looks like
Minor wave C. And, on May 13, we
hit our objective of 2,010. So, what do
we do now? Thats easy: We get out.
There is no other reason to stay in this
trade anymore. Its a high-risk trade,
and when you read the options literature, youll probably see a number of
people who arent in favor of this type
of strategy. Assuming we can get out
and its not a fast-moving market, we
close on May 13. These are the prices:
I sold the June 1850 calls at 168.50
points and bought back the other June
calls one strike at 50.75 points and
the other at 31.25 points. We had a net
credit of 86.50. The implied volatility
was 20.4%. And we had a net profit of
32.00 points, producing a return on investment of 59 percent. As always, the question remains: Did we capitalize on the opportunity at hand? The next chart has the answer.
16
Figure 24
Minor wave C of Intermediate wave
(2) finally peaked at 2,062.75, very
near the previously cited .618 level of
2,032 and then prices turned down. So,
as others in the trading world might
say to us, You got lucky on that one.
However, we know that along with a
little luck, we also had some good Elliott wave analysis to help us.
17
Chapter 3
Ratio Call Spread and Ratio Put Spread
1.
Ratio Call Spread
Buy 1 ITM Call
Sell 2 OTM Calls (Same Strike)
Net Credit or Debit
Neutral to Moderately Bullish
Maximum Risk is Uncapped
Maximum Reward Capped at Difference in Strikes + / - Net Premium
Breakeven: Long Call Strike + Net Debit or - Net Credit
Breakeven: Short Call Strike + Maximum Reward / No. of Uncovered Calls
Figure 25
2.
Ratio Put Spread
Buy 1 ITM Put
Sell 2 OTM Puts (Same Strike)
Net Credit or Debit
Neutral to Moderately Bearish
Maximum Risk Uncapped
Maximum Reward Capped at Difference in Strikes + / - Net Premium
Breakeven: Long Put Price - Net Debit or + Net Credit
Breakeven: Short Put Strike - Maximum Reward / No. of Uncovered Puts
Figure 26
18
The third pair of strategies is the ratio call spread and the ratio put spread similar to the bull call ladder,
bear put ladder pair. With a ratio call spread, youre buying an in-the-money (ITM) call and youre selling two
out-of-the-money calls at the same strike. You may have a net credit or debit. Your market outlook is neutral
to moderately bullish and short-term, about one month. The ratio put spread has the same overall structure,
but you use puts instead of calls, because you would be neutral to moderately bearish.
Now, lets talk about risk. I cant stress the level of exposure here enough. Maximum risk is uncapped. However, your short strikes are closer to the money than the short strikes of the bull call ladder and bear put ladder,
which had the short strikes spread out. In other words, the out-of-the-money puts and calls are more vulnerable,
and your uncapped risk is more severe.
Figure 27
Im not going to go through a trading strategy on these, but if one were to use them, its of great value to know
the optimal Elliott wave characteristics. Figure 27 provides a complete list of these.
Function: Clearly countertrend and at the next two higher degrees, at least, because you have significant uncapped risk. In other words, not just wave two of an impulse wave. You would, for example, do this in a wave
two of a wave three so that even the next two degrees are moving in the direction of the main trend. Since
youre heavily betting on a countertrend move, this buys you more insurance against the countertrend move
somehow morphing into a main trend move. Position: Only waves two or four. Structure: Zigzag. Degree:
Relatively low. Entry Point: The latter stages of the wave position; i.e. wave three of C of wave 2. Prior at the
next lower degree: The same as always: An ending diagonal, truncated fifth wave, fifth-wave extension, etc.
I would rely on rules only for second and fourth waves, due to the uncapped risks. Those are: Wave 2 always
retraces less than 100% of wave 1, and the end of wave 4 can never enter the price territory of wave 1.
19
Figure 28
Ultimately, the ratio call/put spreads
are most likely for those traders who
just cant stay out of the market
they always have to do something.
Whether the high level of risk is worth
it is best visualized in this chart of the
NASDAQ 100. Look familiar? Well,
this is Figure 21 from the previous bull
call ladder section. Remember that we
were able to create a breakeven rate
that was way up there, almost as far
as wave two could go. With the ratio
spreads, though, you want to get in
almost near the end so that you can
push the breakeven up even further to
protect yourself.
20
Chapter 4
Bear Call Ladder and Bull Put Ladder
1.
Bear Call Ladder (Short Call Ladder)
Sell 1 ATM Call
Buy 1 OTM Call
Buy 1 Further OTM Call
Net Credit
Bullish
Maximum Risk Capped at Difference of First Two Strikes - Net Credit
Maximum Reward Uncapped
Breakeven: Short Call Strike + Net Credit
Breakeven: Higher Long Call Strike + Maximum Risk Amount
Figure 29
Up next: The bear call ladder, also known as a short call ladder. In options literature, people may categorize
this strategy as somewhat ambiguous and confusing. Are you bullish? Are you bearish? Youre selling an at-themoney call, but youre also buying two different out-of-the-money calls. Whats going on?
Well, the really interesting thing is that this strategy fits Elliott wave like a glove. The reason being: Wave patterns
are often ambiguous and warrant an alternate labeling. The alternate wave count may be telling you to lean in the
opposite direction, and thats where this strategy helps.
First, well go over the basics as they appear in Figure 29. The bear call ladder is bullish. Its a relatively longerterm strategy about three to six months. You should be able to squeeze out a net credit on this. You sell an
in-the-money or at-the-money call, buy an out-of-the-money (OTM) call and buy a further out-of-the-money
(OTM) call. Your maximum risk is capped; its the difference of the first two strikes minus the net credit. Notice,
maximum reward is uncapped this is the biggest contrast with the bull call spread. Its also going to make a big
difference in what kind of wave positions we choose. We have two breakevens: the short call strike plus the net
credit, and the higher long call strike plus the maximum risk amount (in the area beyond the further OTM call).
In a nutshell, were betting on a big move up. Our bias is in the direction of the main trend. Either way, though,
we have some protection if prices move down or sideways. We only get hurt if prices go in the direction of the
main trend but only for a small move. In other words, were sacrificing a small up move in exchange for a big up
move, a sideways move or a down move. Not a bad deal, but you have to be able to structure the trade so that it
generates a net credit.
21
2.
Bull Put Ladder (Short Put Ladder)
Sell 1 ATM Put
Buy 1 OTM Put
Buy 1 Further OTM Put
Net Credit
Bearish
Relatively Longerter-Term Strategy, 3 to 6 Months
Maximum Risk Capped at Difference of First Two Strikes - Net Credit
Breakeven: Short Put Strike - Net Credit
Breakeven: Lower Long Put Strike - Maximum Risk Amount
Figure 30
Figure 30 shows the same details for the bull put ladder, also known as the short put ladder. Again, its the same
structure except now youre betting on prices to fall. So, youre selling an at-the-money or in-the-money (ITM)
put, buying an out-of-the-money put, buying one further out-of-the-money put, and generating a net credit.
22
Figure 31
Now its time to reveal the ideal Elliott wave context in which to implement this particular strategy. Function: The three strategies up to this point have all required short, sudden countertrend moves. Here, however,
were talking about actionary waves, which are those that move in the direction of the main trend. Position:
Impulse waves waves one, three, and five are the strongest types of waves. Within those, waves three
and five are highly preferable, as they are prime breeding grounds for extensions. Wave one can be extended,
but its not common. The other factor against using this strategy for wave one is that wave one occurs right at
a turning point. You may not be sure whether youve really turned or are still in a countertrend move. Degree:
Of course, is high. Dont get hung up on the actual degree labels its basically a big move. Entry Point:
For waves three and five, after a shallow wave two or four due to the possibility of a flat. The only time you
should use this for wave one is after a key reversal, if ever. The truth is, you normally are not going to get the
huge move in wave one that you get in waves three and five.
Its important to understand why this strategy is so suitable to Elliott wave analysis. Often when a move is
relatively small or drawn out for a long period of time, its difficult to gauge its end. For example: How do
you know when a shallow wave two is over and thus marking the start of a powerful third wave, or whether
its unfolding as an expanded flat? Maybe a triangle in wave 4 has ended, but youre not sure because prices
continue to move sideways. So, around every corner of ambiguity, this strategy lies in wait.
The wave prior at the next lower degree is the same as previous strategies.
23
Figure 32
Lets go through a trading scenario
where we use one of these strategies
in a situation of ambiguity. This is an
Elliott wave-labeled weekly continuation bar chart of heating oil. Lets count
up from the 2007 low: we have Minor
waves 1 and 2 (red), a big extended
3, and now maybe 4. Keep in mind,
heating oil is a commodity. We know
that in commodities the fifth wave is
often extended. We already have an extended third, so chances are we wont
get a repeat performance in the fifth
but we could. That small possibility is enough to move us forward. The
chief question to answer is whether
wave four has ended. Maybe the small
rise from Minor wave 4 is part of an
expanded flat and we come back down. Or, maybe were going to skyrocket up in wave five. The first step into
figuring that out is to look at the retracement made by Minor wave 4.
Figure 33
Figure 33 overlays a Fibonacci retracement table to the chart of heating oil.
As you can see, wave 4 has made a
.236 retracement of wave three. That
is acceptable, albeit shallow. Far more
common to fourth waves is a .382
retracement of wave three. But again,
.236 is still adequate.
24
Figure 34
The next order of business is to assess
where we could go in Minor wave
5. In Figure 34, Ive calculated two
common Fibonacci projection points
by multiplying the net distance traveled of waves 1 through 3 by .382
and .618. We get 3.5247 and 3.9421,
respectively.
Figure 35
Those are possible targets for wave
five. Another thing we can do is use
the Fibonacci dividers that we discussed early on in section one (bull call
spread/ bear put spread) and illustrated
in Figure 11. To reiterate: Wave four
often divides the entire impulse wave
into either the Golden Section or two
equal parts. The chart above identifies
those two areas in the case of heating
oil. The Golden Section would bring
wave 5 to 3.7116, and two equal parts
would bring wave 5 to 4.2448. This
handy guideline gives us two more
targets for this particular strategy.
25
Figure 36
What about time? Here again we can
use Fibonacci analysis to estimate
when wave 5 will end. As a guideline,
wave five can equal the time it took to
finish waves one through three multiplied by .382, .5, or .618. In Figure
36, you can see where these dates fall
into the future on the weekly bar chart.
Our entry point is April 11, 2008, so
in sequential order .382 comes out to
the week ending September 12, 2008;
.5 comes out to the week ending October 31, 2008; and .618 comes out to
the week ending December 19, 2008.
So, now we have a reasonable time
reference.
Figure 37
With price and time targets in place,
we can now set the wheels of this trade
strategy in motion. Were going to do
a bear call ladder on April 11th. In
Figure 37, the daily chart of heating oil
is blown up to magnify the price point
of interest the up leg rising out of
Minor wave 4. Make no mistake, this
move is unclear. The initial drop could
just be wave A of 4, making the rise
wave B (leading to a drop in wave C).
Maybe we get lucky and we skyrocket
in wave 5. Or, the way we lose the
most, wave 5 barely bounces. This is
the chance we take.
So, lets get to the numbers. Ive sold
the September 300 calls at 31.40. On
April 11th, the high was 3.2376 and
the low was 3.1557. If youre confused
by the 300 calls, dont be. The puts and calls that Im dealing on are quoted based on the price (on the right
side of the chart) times 100. For example, 3.00 would be quoted as 300 (3.00 times 100). Thats how these
options are quoted, so from this point forward Ill refer to the prices in the same manner. The September op-
26
tions expire on August 26, 2008, close to the .382 time relationship. That gives us about five months, a suitable
stretch of time since this is NOT a short-term strategy. Remember, were looking for a big move at a relatively
high degree. The 300 calls were in-the-money. We were trading around 315-323. Im going to buy the out-ofthe-money September 330 calls at 18.11. If there is just a small up move, I will be giving up 30 points, but we
knew we had to sacrifice a small move to implement this strategy. Then Im buying further out-of-the-money
September 350 calls at 12.68. Why 350?
If you recall, we said that if wave 5 were .382 times waves 1 through 3, then it would go up to 352.47 (see
Figure 34). Were looking for wave 5 to go at least to 352, with the potential to go much higher. The maximum
risk is capped at 29.39. The maximum reward is technically uncapped, but 395 is a good target, and at 395
we would make 15.61 points. Again, 395 comes directly from the analysis in Figure 34; wave five commonly
equals .618 times the net distance traveled of waves one through three. That target came out to 394.21.
Lets sum it up. At minimum, we should get up to 352. The lower breakeven is 300.61. The higher breakeven
is 379.39. The implied volatility is 35.85 percent. And, were doing this all on April 11th. If prices collapse
past this wave 4, we have the net credit. We really dont have to do anything. We could just walk away. So,
lets see what happened.
Figure 38
In Figure 38, you can see that we did,
indeed, get a big move up. This is now
May 15, and we made a high of 372.28
the previous day this is actually
around the area where wave 5 would
form the Golden Section. (Recall Figure 35 and the guideline of wave four
as a Fibonacci divider.) We still havent
gotten to 395, and it looks quite possible that wave five could extend. So,
we can afford to hold onto this position
for a little while longer. The next chart
reveals whether the decision to stay in
this trade and hold out for further gains
was the right one.
27
Figure 39
Yes, we skyrocketed up even further.
The last bar on this chart, May 22nd,
has a high at 401.53 and a low of
390.80, so we got to that 395 level. Its
time to unwind and get out. So, lets
see how we did. We bought back the
September 300 calls at 102.45, sold
the 330 calls at 74.74 and sold the 350
calls at 58.14. We earned a net credit
of 30.43 points. The implied volatility was 40.49%, however thats a bit
misleading. That was still on the June
contract, which had about two weeks
to run. The September contract was
really down to around 34% so no
major change there. Finally, this trade
produced a net profit of 31.04 points.
Figure 40
Bear in mind, the key to this strategy
was not just the wave count. It was using Fibonacci analysis to give us an approximation of what we would expect.
And, if we pan out a bit further, we can
see how close our projection came to
reality. Our exit day was May 22nd.
On the chart in Figure 40, that date
correlates to the peak of Minuette wave
(iii) (blue) of Minor wave 5. After that,
there was Minuette wave (iv) and (v),
the latter of which unfolded as a fifthwave diagonal. As we have repeatedly
learned from the first three sections
of this course, fifth-wave diagonals
precede dramatic reversals. And thats
exactly what occurred here.
28
Chapter 5
Call Ratio Backspread and Put Ratio Backspread
1.
Call Ratio Backspread
Sell 1 ITM Call
Buy 2 OTM Calls (Same Strike)
Net Debit
Agressively Bullish
Relatively Longer-Term Strategy, 6 Months
Maximum Risk Capped at Difference of First Two Strikes + Net Debit
Breakeven: Higher Long Call Strike + Maximum Risk Amount
Figure 41
The last strategy we will go over is the call ratio backspread and its bearish counterpart the put ratio backspread. These are like the previous strategies we looked at the bear call ladder and the bull put ladder
only they are a lot more aggressive. Lets go over the details for the call ratio backspread as shown in Figure
41. Were selling one in-the-money (ITM) call, buying two out-of-the-money (OTM) calls, and we normally
have a net debit.
Unlike the bear call ladder, were buying these two OTM calls at the same strike, and its not that far out of
the money. If you recall, in the ladder strategy we would buy one lower call and then a much higher call. The
call ratio backspread is a relatively long-term strategy, about six months. Here, maximum risk is capped at the
difference of the first two strikes plus the net debit. Maximum reward is technically uncapped. I say technically because nothing goes to infinity. If we assume a net debit, we just have one breakeven: the higher long
call strike plus the maximum risk amount.
29
2.
Put Ratio Backspread
Sell 1 ITM Put
Buy 2 OTM Puts (Same Strike)
Net Debit
Agressively Bearish
Relatively Longer-Term Strategy, 6 Months
Maximum Risk Capped at Difference of First Two Strikes + Net Debit
Breakeven: Lower Long Put Strike + Maximum Risk Amount
Figure 42
Figure 42 covers its counterpart on the bear side: the put ratio backspread. Again, its the same type of
structure as the ladders, only much more aggressive.
Figure 43
Now lets look at the optimal Elliott wave characteristics. Function: Clearly actionary, in the direction of the
main trend. We dont have a net credit on this; just a net expense or debit. Position: Looking for an impulse,
i.e. third or fifth wave and, hopefully, an extension. Degree: High. We want a big move. Entry Point: This
is another interesting difference from the ladder strategies. Were not looking for shallow twos or shallow
fours anymore. Were looking for a deep wave two or relatively deep wave four, so we can position ourselves
30
aggressively. We do not want ambiguity. We want clarity and confidence. Nothing is 100% airtight, but we want
the signs to strongly suggest that were going into a third wave or fifth wave. Maybe weve just completed an
expanded flat or were right at the final E wave of a triangle before going into the next impulse wave. Perhaps
were ending a series of overlapping ones and twos. The point is that ALL of these scenarios, when they involve ensuing third or fifth waves, can lead to extensions. And, an extension is exactly what we want here. As
always, you will look for three types of structures in the wave prior at next lower degree: ending diagonals,
truncated fifths, fifth-wave extensions, or other equally compelling evidence of a reversal.
Figure 44
So, lets look at the last trading scenario. This is an Elliott wave-labeled
weekly continuation bar chart of natural gas. Were going to start trading in
the week ending March 28, 2008. As
you can see, our interpretation is that
a contracting triangle [Minor waves
A, B, C, D, E (red)] ended forming
Intermediate wave (X). From there, we
started what appears to be an impulse
for Minute waves 6, 7, 8, and 9
(blue).
Figure 45
Figure 45 displays a Fibonacci expansion to show the possibilities for
wave 0 (not shown on chart) after a
deep retracement in Minute wave 9.
Remember, a relatively shallow fourth
wave is a deal breaker for using the
call ratio backspread strategy, since
its an indication the fourth wave may
not be over. We dont want ambiguity.
We want a big move quickly, and there
are compelling reasons to believe a
big move is exactly what were going to get soon. First, there is a deep
completed fourth wave as opposed to a
more drawn out expanded flat in wave
four. Also, natural gas is a commodity,
and fifth waves are often extended
in commodities. We havent had an
extension up to this point (waves 6
and 8 are short), so we are definitely
due for one.
31
The next thing to look at is how far this Minute wave 0 could go. Well, as we learned in the previous section,
wave five often equals the net distance traveled of waves one through three multiplied by .382 or .618. The
.382 level comes to 9.984. As you can see in Figure 46, which shows action up to the week ending March 28,
2008, weve already gone above 10.000. The high a couple of weeks earlier was 10.294, thus the .382 is not
going to work. So, we can rightfully expect wave 0 to at least equal .618 times the net distance traveled of
waves one through three. That comes out to 10.800. If wave 0 is extended, it should equal 1.618 times the
net distance traveled of waves one through three, or 14.256. So, note those points: 10.800 at minimum and
14.256 as a possible extension.
Figure 46
If we want to amass a few more targets
for Minute wave 0, we can always
consult another familiar Fibonacci
guideline for fourth waves. This states
that the beginning (or end) of wave
four often divides the entire price range
of waves one through five into the
Golden Section or two equal parts. As
you can see in Figure 46, the former
area comes to 12.43 for the end of
wave 0, and the latter to 13.75. Seeing
that 13.75 is relatively close to 14.256,
were going to keep those two levels
in mind as possible termination points
for Minute wave 0.
Figure 47
Now, what about time? This is a Fibonacci time zone chart. Our starting
point is the beginning of Minute wave
6. From there, we see each Fibonacci
number of weeks: 2, 3, 5, 8, 13, 21,
34, and 55. We know were going to
have to go further out on our expiration, probably around six months from
our exact trading date, which is March
27, 2008. So, somewhere between 34
weeks (August 15, 2008) and 55 weeks
(January 9, 2009) seems like a reasonable target.
32
Figure 48
Again, we can use the Fibonacci guideline for fourth waves acting as dividers to accrue a few more objectives in
regard to time. This chart shows that
if Minute wave 0 ends on August 1,
2008, the end of Minute wave 9 will
have divided the entire time duration of
waves 6 through 0 into the Golden
Section, i.e., .382 for the amount of
time to the end of wave 9 and .618
for the remaining amount of time to
the end of wave 0. We had August
15th in the previous time chart, so it
looks like were going to need at least
until August in terms of our expiration date.
Figure 49
Before we start the trade, we need to
prepare for a plan B exit strategy in
case prices fall. If were wrong, we
would look to unwind to try and salvage something in terms of premium.
As we can see in Figure 49, Minute
wave 9 made a deep retracement
of Minute wave 8 at 8.664 near
the .618 level of 8.610. We know that
wave four cannot end in the price territory of wave one and that the top of
wave 6 came to 8.481. So in terms
of unwinding the trade, well look at
those levels.
33
Figure 50
Now that we have our price and time
objectives for wave 0 and a wellbuilt exit strategy, we can confidently
begin the trade. The last daily bar in
Figure 50 falls on March 27, 2008,
where the market traded from 9.645
to 9.346. So, were going to do the
call ratio backspread on that date.
Were going to use the September
calls, which expire on August 26th.
Ideally, well unwind the trade at least
a month prior to expiration, before our
exposure to time decay accelerates.
So, lets get to the numbers. On March
27, sell one in-the-money September
9.00 call at a premium of 1.571, and
buy two out-of-the-money September
9.500 calls at a premium of 1.310 per
each call. Net debit is 1.049. (Risk note: each one point is $10,000 a contract.) Our maximum risk is 1.549.
Maximum reward is uncapped, but if Minute wave 0 gets to 13.750, our reward would equal 2.701.
Now, why did I pick these strikes and end up with this type of situation? The key is the breakeven point:
11.049. If you recall, we said that at a minimum wave 0 would equal .618 times the net distance traveled
of waves one through three at 10.800 (see Figure 45). What I was attempting to do here is structure the
option trade so that I minimize the net debit and bring the breakeven as close to 10.800 as possible. Then,
if we get the bigger wave or the extension, were going to be in profit territory.
Implied volatility is 38.17%. And, as a target, we are looking at two main objectives: 13.75, where wave four
divides the entire price range of waves one through five into two equal parts (see Figure 46), and 14.256,
where an extended wave 0 equals 1.618 times the net distance traveled of waves one through three (see
Figure 45).
On the downside, we unwind at 8.480. Remember Figure 49 identified our exit point as the top of wave 6
at 8.481. So, I went one tick below that level to establish where we would get out.
34
Figure 51
Lets zoom ahead to see what happened. We did get a big move up. At
this juncture, the high on the very last
bar of the chart is 10.844. So, we have
now achieved the 10.800 minimum
established in Figure 45. But it looks
like we have greater potential. Keep
in mind that were looking for about
13.750 and on up to 14.256. So, were
going to keep the position.
Figure 52
Again, we moved up even further.
Now, the high so far is 11.794 still
not quite at our target. Were going to
stay in and ride this out.
35
Figure 53
In Figure 53, Ive labeled the upward
progress from the March 20 low as
Minuette waves (i), (ii), (iii), and (iv)
(red). Ive also drawn a trend channel
to delineate how much higher Minuette
wave (v) of Minute wave 0 could possibly go. Lets follow the channel and
see where it takes us.
Figure 54
There certainly was more UP to
this uptrend. The high on this chart is
13.694, just six ticks away from the
initial 13.750 target. From there, youll
notice that weve come down, raising
the question as to whether the wave 0
rally is over. We got close to 13.750,
but certainly not the secondary target
of 14.256. The objective thing to do is
to wait and see if we break the lower
part of the trend channel. If that occurs,
its time to get out.
36
Figure 55
Indeed, in Figure 55 you can see that
prices penetrated the lower boundary
of the trend channel. There is no longer
any reason to hold onto this position.
So, on this date, July 8, 2008, and at
this price level (we reached a high of
12.970) we close out this call ratio
backspread. In the lower right hand
corner, you can see all the particulars
of the close in green. The most important detail is that we have a net credit
of 2.503 points and a net profit of 1.454
points. This is a great example of how
the key to riding out a trade is not just
in counting waves and sticking to your
target. We also used the guideline of
channeling and waited for a break of
the trend channel before closing out
our position. Of course, we would have done much better had we gotten out at the top of Minuette wave (v)
(red) of Minute wave 0, but we waited to see if the market continued to extend.
Figure 56
If you want to see what happened
after that, Figure 56 shows that there
was a swift and sharp decline. That
was to be expected because the entire
move from the March 20, 2008, low of
Minute wave 9 was an extended fifth
[Minuette waves (i) through (v) (red)].
And what do we have after an extended
fifth? A dramatic reversal.
37
Figure 57
To cap things off, heres a quick reference guide to all five pairs of trading strategies covered in this course.
38
Chapter 6
Questions and Answers
Q. Why dont you use a bull call spread for fifth-wave ending diagonals?
Gorman: Although diagonals are, by definition, actionary waves, there is very little action actually going
on. In fifth-wave diagonals, you probably dont even know youre in the pattern until youve seen waves
one, two and three, or until youve had three consecutive zigzags that are slowly moving in the direction
of the main trend. In other words, diagonals use up a lot of time to make relatively little progress. The
best use you can make of a diagonal is to go for the next move after it ends. Remember: diagonals often
precede dramatic reversals.
Q. Are these strategies suitable for triangles?
Gorman: No. All of the vertical spread strategies discussed in this course are for directional moves only:
either up or down. Triangles are sideways patterns. Now, if its a certain wave within that triangle, then
yes. As we know, triangles are made up of zigzags, and three of the structures we spoke of in this course
are best suited for zigzags: bull call spread/bear put spread, bull call ladder/bear put ladder, and ratio call
spread/ratio put spread. However, for triangles themselves, absolutely not.
Q. Could you better explain the use of Fibonacci time relationships?
Gorman: During this course, I concentrated on three main Fibonacci time relationships. They are as
follows:
1. In terms of time, wave five will be equal to .618 times the net time duration of waves one through
three.
2. Wave four either the beginning of wave four or the end of wave four will divide waves one
through five into the Golden Section (.382, .618) or in half (two equal parts).
3. The entire time of waves one through five (in terms of trading days or weeks) will be a Fibonacci
number; those are: 2, 3, 5, 8, 13, 21, 34, 55 and so on....
There are several sources in which you can find expansive material on Fibonacci time relationships. Right
off the top are these references: Elliott Wave Principle Key to Market Behavior by Frost and Prechter;
Bob Prechters Beautiful Pictures; and the online trading course featured on our website, elliottwave.com,
titled, How to Spot Turning Points Using Fibonacci.
Q. How do you keep track of all of your alternate counts, and how many alternates will the analysis
track?
Gorman: You probably would have, at the most, two alternate counts. You have your main count and one
alternate in case the main count does not materialize. I would say maybe one more after that. With all the
charting systems that people have today, its not difficult to keep track of those counts. Also simplifying
things is the easy access to annotation tools and the ability to save information.
39
Chapter 6 Questions and Answers
Q. In Chapter 5 on ratio backspreads, you predicted a fifth wave by using the movements of waves one
through four. How did you do this?
Gorman: First, let me say there are many Fibonacci relationships. If you like this type of analysis, I highly
recommend Bob Prechters Beautiful Pictures. As for the matter at hand I used the second Fibonacci
time relationship as described in question number 4 above. To reiterate: the end of wave four will often
divide waves one through five into either the Golden Section (.382 or .618) or in half (two equal parts). So
when I was looking at the end of wave four, I was looking at how that would divide the entire sequence. I
wasnt multiplying one through four times some number.
Q. What charting system do you use?
Gorman: All of the charts in this course were made with Genesis FT. We also use CQG at Elliott Wave
International.
Q. Are there strategies you can use to trade expanded corrections?
Gorman: Well, if its a correction and its expanded, the analogy is really the triangle or possibly a flat
a double-three flat. And those really are sideways or range-bound trades. These entail certain types of
butterflies, condors, and/or other similar strategies. In options literature, they are referred to as income
strategies, because youre trying to generate income in the absence of a big price move up or down.
With no more questions on the table, Ill end on this final note: If youre interested in resources about options, one good book is called The Bible of Options Strategies by Guy Cohen. And in terms of Elliott wave
and Elliott wave patterns, we have a number of resources at our website. We have online courses on all the
different patterns, Fibonacci, individual stocks, and other technical indicators.
40
EWI eBook
How to Use the Elliott Wave Principle to Improve Your

Options Trading Strategies
Course 1: Vertical Spreads
By Wayne Gorman, Senior Tutorial Instructor, Elliott Wave International
Published by New Classics Library
For information, address the publisher:

New Classics Library
Post Office Box 1618
Gainesville, Georgia 30503 US
www.elliottwave.com
ISBN: 978-0-932750-36-5

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HOW TO USE

THE ELLIOTT WAVE PRINCIPLE

How to Use the Elliott Wave Principle to Improve Your

Chapter 1 Bull Call Spread and Bear Put Spread

Bull Call Spread

Buy 1 ATM Call

Sell 1 OTM Call

Relatively Longer-Term Strategy, 3 to 6 Months

Maximum Risk Capped at Net Debit

Maximum Reward Capped at Strike Difference - Net Debit

Breakeven: Long Call Strike Price + Net Debit

Chapter 1 Bull Call Spread and Bear Put Spread

Bear Put Spread

Buy 1 ATM Put

Sell 1 OTM Put

Relatively Longer-Term Strategy, 3 to 6 Months

Maximum Risk Capped at Net Debit

Maximum Reward Capped at Strike Difference - Net Debit

Breakeven: Long Put Strike Price - Net Debit

Chapter 1 Bull Call Spread and Bear Put Spread

Chapter 1 Bull Call Spread and Bear Put Spread

Chapter 1 Bull Call Spread and Bear Put Spread

Chapter 1 Bull Call Spread and Bear Put Spread

Chapter 1 Bull Call Spread and Bear Put Spread

Chapter 1 Bull Call Spread and Bear Put Spread

Chapter 1 Bull Call Spread and Bear Put Spread

Bull Call Ladder (Long Call Ladder)

Buy 1 ATM Call

Sell 1 OTM Call

Sell 1 Further OTM Call

Relatively Shorter-Term Strategy, 1 Month

Maximum Risk is Uncapped

Maximum Reward Capped at Middle Strike - Lower Strike - Net Debit

Breakeven: Long Strike + Net Debit

Breakeven: Total of Short Strikes - Long Strike - Net Debit

Chapter 2 Bull Call Ladder and Bear Put Ladder

Bear Put Ladder (Long Put Ladder)

Buy 1 ATM Put

Sell 1 OTM Put

Sell 1 Further OTM Put

Relatively Shorter-Term Strategy, 1 Month

Maximum Risk Uncapped

Maximum Reward Capped at Higher Strike - Middle Strike - Net Debit

Breakeven: Long Strike Price - Net Debit

Breakeven: Total of Short Strikes - Long Strike - Net Debit

Chapter 2 Bull Call Ladder and Bear Put Ladder

Chapter 2 Bull Call Ladder and Bear Put Ladder

Chapter 2 Bull Call Ladder and Bear Put Ladder

Chapter 2 Bull Call Ladder and Bear Put Ladder

Chapter 2 Bull Call Ladder and Bear Put Ladder

Ratio Call Spread

Buy 1 ITM Call

Sell 2 OTM Calls (Same Strike)

Net Credit or Debit

Neutral to Moderately Bullish

Relatively Shorter-Term Strategy, 1 Month

Maximum Risk is Uncapped

Maximum Reward Capped at Difference in Strikes + / - Net Premium

Breakeven: Long Call Strike + Net Debit or - Net Credit

Breakeven: Short Call Strike + Maximum Reward / No. of Uncovered Calls

Ratio Put Spread

Buy 1 ITM Put

Sell 2 OTM Puts (Same Strike)