How I Trade Gap Up - By Buying Puts
When the stock gaps up on news then analyzing this news is very important. Before the market opens reading the news on the stocks which are gapping up is crucial to understanding what the stock would eventually do after the stock starts trading during normal market hours.
If the stock is gapping up for no good reason, that is no substantial news to justify the gap, then it is likely a good candidate for fading the gap. In other words if the gap is overly exaggerated the stock will likely reverse its direction to the downside and if the gap amount is significant then a trader can buy Puts to take advantage of the reversal. Another factor which helps in my decision whether to fade the gap or trade in the direction of the gap is where the stock is trading at open with respect to the resistance. If the stock gaps up and hit the resistance and unable to conquer the resistance right at the beginning then it has very high chance that it will fail to cross the resistance later during the day and rather it will sell off . If this is the case then a trader can buy Puts with stop 50 to 70 cents above the resistance line and lock gains when stock approaches the support. The potential between resistance and support should be enough to justify buying Puts as option trading requires certain dollar amount move to justify the spread between bids and ask.