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Options: Credit Puts in a Swing Trading Program

By  Jun 15, 2012

Topics: Finance & Investing

Swing traders normally use shares of stock; but do they short sell to play a bearish trend? or do they hold and wait for the next bullish move? If they do, they're missing half of the swings. Options make more sense, anjd short optinos could make the most sense of all.

Credit calls and puts make sense for swing trading under the following circumstances:


            1. Expiration is going to take place in one month or less. This means time decay will be at its most accelerated. The problem with long options is that you rely on intrinsic value and you have to struggle with the time decay offset. With short calls at the top of the swing and short puts at the bottom, you don’t even need intrinsic value. Time decay does all the work for you.


            2. You pick the right strikes. Your risk is lowest and advantage at its greatest when your strikes are slightly out-of-the-money. Even if the option moves in the money, the time decay offset is very difficult to overcome in this late period. If a position does go in the money, roll or close.


            3. You are willing to take small losses when you do call it wrong, rather than risk bigger losses later or an unwanted exercise.


Are naked options really safe enough for a swing trading program? They are, as long as you know how to track them. So you need to monitor implied volatility and time your trades to move in and out at just the right time. You also need to limit your selection to high-probability trades, those over 80%. If probability starts trending under 80%, close down the position.

            Even though you are writing uncovered calls and puts under this strategy, you can continue to think of yourself as conservative. You are likely to be in an option positing between three and five sessions, and no more. This is the typical reaction and over-reaction trend period. It also means exposure to risk is quite limited.

            As a final note about using credit calls and puts: Remember that risk has to be defined not by a specific strategy, but by how , when and where it is used; and also on when you open and close a position. So uncovered options can be low-risk if the guidelines for a swing trading and timing strategy are remembered.