Most “swing traders” -- those moving in and out of positions in two- to five-day short-term price swings -- use shares of stock for their strategy. But options can vastly expand your swing trading program with less risk and greater leverage. Here are five ways this can work for you.
1. Options reduce market risks. When you use stock to swing trade, you buy shares at the bottom of the swing and sell at the top. Then you sell short at the top and buy to close at the bottom. This is expensive and risky, due to the process of short selling. With options, both sides can be played long. You buy calls at the bottom, closing them at the top; and you buy puts at the top, selling at the bottom.
2. Cost is significantly lower with options. Every option controls 100 shares of stock but costs a lot less, averaging about 5% of 100 shares cost. Even so, in-the-money options match stock price movement point for point.
3. Market risk is much lower. When you buy options, you can never lose more than the amount you pay. Yes, that’s 100%, but the amount it risk is much lower.
4. Options let you diversify broadly. With stock you can only buy or sell so many shares, due to capital and margin limits. With options, each contract controls 100 shares so you can trade on many more issues at the same time.
5. This is one of the few option strategies that works best near expiration. The dilemma for most long option positions is impending expiration and time decay. With swing trading, you only expect to be in a position a few days. So the greatest advantage is found when the options expire in less than one month, and when the option is at the money. This is when price movement will be most responsive to stock prices.
Options provide an alternative, and this illustration is based only on long calls and puts. Going even further, you can sell covered or uncovered positions, combine long and short options in synthetic stock positions or collars, use short calls and short puts exclusively, create ratio writes and weight bullish or bearish sides on the swing. In other words, there are many varieties you can use to create and control the most effective swing trading strategy possible.
Finally, you can fine-tune the timing of your option trades by using reversal and confirmation signals; and also by timing entry or exit based on the option’s volatility. Mastering this gives you a true edge over more traditional swing trading systems. Check Volatility edge to learn more.
Michael C. Thomsett (firstname.lastname@example.org) is author of FT Press’s “Options Trading for the Conservative Investor.” He is an instructor with the New York Institute of Finance. He teaches five courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.” He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com