Anyone who has heard of swing trading knows what’s involved: open positions on exaggerated price swings, wait for the correction and then close. A swing trader generally expects to see the round trip within three to five sessions.
The signals are well-known, too: narrow-range days (NRDs) often signal the end of momentum. A reversal day, of course, is the turn. And a volume spike is the third of three popular swing trading reversal signals.
Of course, there is more: candlestick reversals, momentum oscillators, and any technical signal occurring at or near resistance or support. But swing traders face a problem: Using shares of stock limits any ability to diversify just because of portfolio and capital limitations. And many swing traders get in at the bottom of swings with long stock but avoid the top because they don’t want to go short.
Options solve both of these problems. The great leverage possible with options increases potential many times while each contract controls 100 shares for a fraction of the cost. Risks are also lower if you use only long options, because maximum loss is limited to the relatively small cost of the option. Finally, you can play the bearish swings with long puts, helping avoid the risks of going short on either stock or options.
Going beyond the basic swing trade with long calls and puts, you can also use short side trades including covered calls; collars; calendar spreads; and synthetic long or short stock. The synthetic alternative is quite interesting because net cost is close to zero, but the position duplicates movement in the underlying.
There is even more. You can weight the trade with ratio writes or variable ratio writes, making the favorable movement more profitable than with a straight one-to-one.
Swing trading with options opens many doors beyond the traditional use of shares of stock and reduces risks while expanding diversification. This is one of many ways that options just make sense.
Michael C. Thomsett
About this week’s Heavy Hitter: Michael C. Thomsett is a widely published options author, with six options books in print, published by John Wiley & Sons, FT Press, Amacom Books, and Traders Library. He blogs at FT Press, Minyanville, Benzinga and Seeking Alpha.