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Chapter 5. Derivatives > Action Plan

Action Plan

The phenomenal growth of derivatives trading has had a profound influence on equity investing. For one thing, it has created forces of supply and demand that are not necessarily linked to conventional fundamentals. In fact, sometimes there is little connection between inflows and outflows into various shares and the prospects of the companies those securities represent. Consequently, this can spell opportunity for investors who focus on traditional investing methods, whether they are based on technical or fundamental factors. Perhaps the first question to ask when doing your research is whether a potential investment is linked to options and futures or some widely followed market barometer. If so, are there current or prospective forces at work that are likely to temporarily unsettle supply and demand? Has there been—or is there likely to be—an announcement that a company’s shares will soon be added to or dropped from a widely followed index? While there are no easy ways to get answers, heading to the Web sites of the companies involved can be a good way to get started.

Other points to consider are whether the shares you have been monitoring are part of an index that has seen widespread speculative interest or, alternatively, that has significantly lagged behind other bellwether averages? Relative weakness may reflect theme-based trading that has little to do with the business success of the companies whose shares are being affected. In addition, the periods when monthly and quarterly expirations come around, far from being a time to stay away, can represent potentially profitable opportunities to jump in with both feet. If the stocks on your radar have listed options, the appearance of a significant level of open interest at the start of the final week of trading—more, say, than the average daily volume that occurs in the shares—often indicates that technical forces may dominate the price action in the days ahead. For insights and further information, Web sites such as www.cboe.com and http://finance.yahoo.com can help.


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