Swing trading is a description of strategies designed to move in and out of open positions as quickly as possible (usually 2 to 5 trading days), take small profits, and move to the next one. Most traders use stock for swing trading; but options just make good sense as the vehicle of choice for swing trading. When you swing trade using stock, there are several problems:
1. You are limited by your cash and margin maximum, whereas options are cheaper and for a small fraction of the cost, allow you to control price movement in 100 shares. Thus, you have great leverage but risks remain low.
2. The combination of option diversification and leverage cannot be matched, especially when you realize that these features do not increase risk. Most forms of leverage (like margin borrowing) increase your risks, but not so with an options-based strategy.
3. Options are less risky because you can never lose more than the premium paid for a long position.
4. You cannot play both sides of the swing without high risks. Stock-based swing trading demands shorting stock at the top of the swing, which is expensive and high-risk. With options, the long put is a much safer and easier bearish play.
In summary, just the basic strategy of opening long calls at the bottom and long puts at the top, makes swing trading flexible, affordable and low-risk. It is also one of the few strategies where using soon-to-expire, at the money or slightly in the money options make the most sense. Swing traders move in and out of positions in a 3- to 5-session time frame. Options at or slightly in the money that expire in a month or less have very little time value and are most likely to respond to the underlying price movement.
This is one of many low-risk trading ideas every options trader can use. The great advantage to options for swing trading is not only in the profit potential, but also in the way this reduces your market risks.
Option-based swing trading can be accomplished in a very low-cost environment. For example, setting up synthetic long stock positions at the bottom of the swing, and synthetic short stock positions at the top is a great way to create no-cost or no-cost swing trading positions. While both synthetics require one side to be short, the risk is likely to be manageable if you also rely on strong reversal signals and their confirmation.
I have written a book on this topic being published by Palgrave Macmillan, called Options for Swing Trading In this book, I considered all of the possible combinations of long and short options with a keen focus on risks and potential profits. Following is the complete table of contents:
Introduction: Problems of Risk in Most Trading Systems
Chapter 1 - Options: Trading Basics
Chapter 2 - Swing Trading: The Basics
Chapter 3 - Dangerous Waters: Risk Inherent in Comprehensive Swing-Based Strategies
Chapter 4 - Marginal Potential: Leverage Limitations in Swing Trading with Stock
Chapter 5 - Elegant Solutions: Options to Address the Risk and Leverage Issues
Chapter 6 - In and Out: Entry and Exit Criteria for Swing Trading
Chapter 7 - Powerful Timing Tools: Expanding Swing Signals with Candlestick Reversals
Chapter 8 - Flexing Your Muscle: The Power of Options Close to Expiration
Chapter 9 - Swings Maximized: Timing the Swing with Ex-dividend Date
Chapter 10 - Strategy # 1: Long Option Approach, a Basic Solution
Chapter 11 - Strategy # 2: Long/Short Call Strategy, Uncovered Short Side
Chapter 12 - Strategy # 3: Long/Short Call Strategy, Covered Short Side
Chapter 13 - Strategy # 4: Long/Short Call Strategy, Ratio Writing on the Short Side
Chapter 14 - Strategy # 5: Long/Short Put Strategy
Chapter 15 - Strategy # 6: Short Option Strategy
Chapter 16 - Strategy # 7: Synthetic Option Positions Strategy
Chapter 17 - Strategy # 8: Multiple Contracts and Weighting with Ratio Calendar Spreads
Chapter 18 - Strategy # 9: Expanded Iron Butterfly Swing Trading
Epilogue - The Big Picture: Swing Trading and Your Portfolio
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