Swing Trading: The Long Option Method

This article is the second of six on the topic of using options to swing trade. The topic this week is the most basic of swing trading methods, the use of long options only. Swing traders want to open bullish positions at the bottom of the swing, and close these at the top; and then open bearish positions at the top and close them at the bottom. The “swing” itself is the emotional over-reaction typical of markets and based on earnings surprises, rumors, or unexpected volatility. Most traders follow these matters closely, which creates those exaggerated swings. And swing traders make their moves knowing that prices tend to reverse and offset exaggeration very quickly -- generally within three to five trading sessions. The traditional swing trading method using stock requires purchasing shares at the bottom, waiting for price appreciation, and then closing the position. At the top, swing traders expect to sell short and wait for a price decline, then buy to close. The problem, though, is that shorting is high-risk and expensive. Consequently, many swing traders only play the long side of the swing. With options in place of stock, you expand and diversify and take advantage of leverage. At the same time, long option trading is much less risky than either side of the stock-based swing trade, and potentially more profitable as well. The options strategy involves buying calls at the bottom and selling at the top of the swing; and then buying puts at the top and closing them at the bottom. Risks are limited to the premium cost of the long options. It's true that if your timing is off (and it will be at times) you lose 100% of the premium, but remember the option premium is a small fraction of the cost for the 100 shares the option controls. If you rely on strong reversal and confirmation, this is one of the lowest-risk methods of swing trading you are going to find. Focusing on options expiring within a month or less, and buying at the strike or slightly in the money, the value is most likely to track close to the underlying; as the option moves further in the money, its value is going to closely track point for point. While out-of-the-money options will be cheaper, you fight an uphill battle to get into intrinsic territory, which you need in order to get those 3- to 5-day profits. This is one of the few options strategies that is maximized using soon-to-expire long options. Whether you use options or other strategies, you can expand your trading with numerous low-risk ideas and make the whole thing quick and easy. Check the many ideas for profitable trades at this link if you want to expand into options and beyond while keeping risks as low as possible. Please look for the remaining four articles in this series, to follow over coming weeks:

• long and short calls or puts in combination
• short options only
• variable weighting on one side of the swing
• spotting the swing reversal