Swing Trading: Variable Weighting

This article is the fifth of six on the topic of using options to swing trade. The topic in this article is weighting on one side or the other of the swing, using options. Using options to focus more on either uptrend or downtrend is an effective method for augmenting the swing itself. The strategy assumes that you have an opinion about the prevailing direction of movement in the underlying, and that momentum confirms your opinion. So as a starting point, you can coordinate a weighting decision by checking some of the best momentum oscillators like RSI or MACD. There are numerous methods for weighting one side or the other. On the bottom of the swing, bullish weighting can include: - Increasing the number of long calls opened (for example, opening two long calls will create twice the profit of upward movement in the underlying when in the money; and of course, three calls will triple the effect). - Increasing the number of short puts opened (this does the same on the downside, and weighting long puts accelerates out-of-the-money profits as long as the underlying price continues to rise). - Combining long calls with short puts, creating a synthetic long stock position (the synthetic is low-cost or no-cost because the long premium is paid for by the short premium, and yet the overall position reflects price movement in the underlying point for point in the money). For example, the 3-month chart for Google

as of mid-March, 2012 presented several examples of where weighted swing trading strategies would have worked. Note the labeled uptrend at the beginning of the year, a point where Relative Strength Index (RSI) moved into the overbought range. This signaled a likely reversal and downtrend. As soon as this condition appeared, a swing trader -- relying on the peaking uptrend confirmed by RSI -- could open a weighted series of long puts or short calls, in the belief that prices would fall in coming sessions. This did occur and culminated in a significant downward price gap of 50 points. This by itself would be the signal point to close the positions opened previously and take profits. Another important signal was found in March with a “hammer,” a candlestick with a relatively small real body and a long lower shadow. When this appeared after a downtrend, it is a bullish signal. Although the downtrend preceding this was only three sessions, it was a good signal. A swing trader at this point might weight a move either by opening long calls or short puts. On the upside, bearish weighting is accomplished with the opposite: - Increasing the number of long puts opened (as with the bullish side, this bearish approach creates ITM profits from the puts at a rate greater than movement in the underlying). - Increasing the number of short calls opened (this is a higher-risk strategy in the event that the underlying price rises; but if your indicators say the price will move south, this approach increases current income and cushions the risk, leading to profitable “buy to close” orders). - Combining long puts with short calls, creating a synthetic short stock position (the risk is greater due to the short call, but also consider making this into a collar by holding shares of the underlying). The weighting concept can be expanded and made more conservative by also holding stock when short calls are employed. However, even a covered call can be effectively weighted with the use of a ratio write. Even better, a variable ratio write expands income without adding significantly to risk, since higher strikes can be closed, covered or rolled before the position move in the money. Another form of weighting involves backspreads, in which “cover” of short positions is accomplished by buying a larger number of higher-strike calls (or lower-strike puts). 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

at this link if you want to expand into options and beyond while keeping risks as low as possible. Options are exceptionally flexible products for swing trading, and they allow traders to control risks while leveraging capital, in a lower-risk method than with shares of stock. Please look for the last articles in this series, to follow in a few days: how to spot the swing reversal.