Options for Specialized Trading: Leveraging the Technical Approach
A popular system in use today is swing trading. This is an excellent technical trading method for anyone who wants to become involved in short-term market plays, normally lasting between two and five days.
Options are perfect devices for swing traders, and for one simple reason. If you swing trade using stocks, your potential range of trades is severely limited and involves significant risks, at least on the short side. For example, if you want to swing trade using lots of 100 shares, a $25 stock demands a $2,500 commitment, but an option on the same stock will be available for a small fraction of that cost. An $85 dollar stock requires $8,500 in available cash to place at risk but, again, an option on the same shares will cost far less.
With these important distinctions in mind, the swing-trading strategy is perfectly set up for options in place of stock. Remember these key points:
Smart Investor TipThe leveraging feature of options makes swing trading practical, affordable, and less risky than using stock. This is an example of how options favor short-term traders.
- Swing traders are not interested in long-term investing. A swing trader wants to create extremely short-term profits by moving in and out of positions in two- to five-day trading ranges. Because they are not interested in the long term, swing trading and options are a good match.
- Because options cost less than stock, the range of possible swing trades is expanded with the use of options. Imagine starting a swing-trading strategy with $10,000 available. Using stocks, you could trade four stocks in the range of $20 to $25. If you have to go short, you would be required to keep cash on hand to cover margin requirement. However, with the same $10,000, you could trade many more stocks, avoid the margin requirement involved with going short, and still make the same profits on each trade.
- Swing traders want to open both buy and sell positions, meaning they may have to short stock. But with options, swing traders can buy puts instead of selling stock. Many swing traders simply avoid opening short positions in stock because the risk is so significant. So they cut out half of their potential trades, and limit activity only to the buy side. With options, you can go long on calls and puts, meaning both sides can be involved without extra risk.
- Swing trading is set up for very short-term positions, meaning this is a perfect strategy for in-the-money options that will expire within one month. You are not likely to hear of very many options strategies where in-the-money options about to expire are favored above all others. But swing traders intend to be in positions for only two to five days, so soon-to-expire options are perfect for this purpose. Because time value will be at or near zero in these options, the cost of long positions will be limited to intrinsic value. Swing traders will want to use in-the-money options because they need the point-for-point price reaction, and options scheduled to expire in a month or less (but with current market value of the stock only a few points from striking price) are ideal.
- Options present much lower risk than stock positions. Swing traders are not going to time their decisions perfectly. No one is right 100 percent of the time. So in the use of long or short stock, the potential risks are significant. In fact, because swing traders want to move in and out of positions in only a few trading days, having capital tied up in positions beyond that time prevents swing traders from realizing their full potential and translates to many lost opportunities. In those cases where the timing is wrong, using soon-to-expire options is lower risk because less cash is involved. A missed timing situation does not destroy the strategy.
By Michael C. Thomsett