I'm going to take you through my routine and thought processes when I'm looking to take an option trade. Even if you don't trade options, this analysis should help with analyzing and deciding whether to pull the trigger on any trade. I'm going to use the RTH as my example since I just picked up some contracts today.
The first step for me is spotting a price pattern on a daily chart from the hundreds of charts I pour over. Usually a 3-6 month chart provides these "pattern trained" eyes with plenty of opportunities. That gets the process started and gets me a candidate. In this case, RTH. The next step is to take a look at the 5 year weekly chart...
I'm looking for obvious areas of support and resistance. Not exact levels, but general areas that I can draw in with a crayon, not a pencil. I may draw some trendlines too, but I basically want to see if the big picture is accumulation or distribution. I can see from this chart that volume fell off rather dramatically on the recent climb and prices rolled over exactly where you'd expect given my support/resistance line.
The next step is the 2 year daily chart...Now I'm looking a little closer at the price action. Drawing support and resistance lines and trend lines. I want to know if there are any longer term trend lines that may affect this trade. Not much here.
Next, I pull up the 1 year daily chart...On the 1 year chart, I'll usually look at the Fib. retracements. As well as the 50 & 200 day moving averages (not shown so as not to clutter). I know that prices are currently bouncing between the 50 and 200 day and I can see from the chart above that prices closed below the 38% fib yesterday. If I posted the 200 day on the chart, you'd see that it acted as support yesterday. The next fib level is at $69, noted.
Onto the 6 month chart...
Here's the double top pattern and now I can draw in my neckline or pivot point. I measure the pattern from peak to trough giving me a target of about 8 points on a breakout. I always want to see a minimum of a 10% measured move if I'm going to take down options.
Now it's time to zoom in on the 30 day, 30 minute chart...I have to smile because when I look at this chart, I see the ideal entry at the close today. This is the spot of least risk. RTH is at resistance and up against the 5 day moving average. If it starts to move against me from here I can make a quick exit and save some of the premium. However, in this environment, support and resistance are being gamed daily. I've noted the obvious manipulation, as have others. I'm much more likely to position myself to lose the entire premium and only risk 1% of my portfolio on each option trade. If I'm running hot and the market is doing what I expect, I may up that to 2%.
A few words of wisdom or random thoughts from experience...
When it comes to choosing an option, I'm almost always looking 1 strike out and making sure it's liquid. There's nothing worse than losing 20% on the way out because of a large spread. Buy enough time to profit from the expected move, but not too much time. Don't pay for more time than you need. The big picture always plays an important role as well... 3 out 4 stocks are going to follow the general markets. Swing trading options in a consolidating market will eat away at your portfolio, the big money is made within the trends. Closing prices are significantly more important than the intraday breaks of support and resistance... unless you're prepared to jump right back in, base decisions on the close! A high $VIX is more conducive to being an option seller rather than a buyer because options get more expensive as implied volatility rises. Remember that when the $VIX is above 70 and you're ready to buy calls because the bottom has arrived... you could be right and still lose money!!