4 Points About Swing Trading with Options

01/12/2015 8:00 am EST

Focus: OPTIONS

Michael Thomsett

Founder, Thomsett Publishing Website

Most swing traders use stock, but option trader Michael Thomsett, of ThomsettOptions.com, thinks options may be a better choice; here, he outlines four specific advantages to using options for swing trading.

Swing trading works well with options for many reasons, including being able to execute the strategy with less risk and more leverage.

Swing trading is an attractive strategy for short-term traders. Similar to day trading, the swing trader normally expects to profit from three- to five-day short-term price swings. The theory is based on the observation that short-term price movement is invariably an overreaction to whatever is taking place; earnings reports, rumors, or even market-wide movement. These overreactions correct within that three- to five-day time frame, and swing traders seek entry and exit signals.

Most swing traders use stock, but options may be a better choice. This is especially true for options expiring within a couple of weeks because, unlike most other options strategies, the lack of time value is advantageous when the option is slightly in-the-money.

There are four specific advantages to using options for swing trading:

  1. Risks are lower. The market risk of owning stock is a well-known factor in buying and selling stocks. A single option gives you control over 100 shares, for costs between 5% and 10% of the cost of 100 shares of stock. You can never lose more than the cost of buying the option; and although that is 100%, you have much less cash at risk. This market risk is always present whether you buy and hold stock for the long term, or take profits whenever they materialize. Options in a swing trading strategy reduce market risks instead of increasing them.
  1. There is no need to go short. A big risk in short selling when using stock is that you have to go short to play the downside. At the top of the price swing, you expect a reversal and a decline. With stock, you have to go short to take a position, which is a huge risk. For this reason alone, many traders swing trader only at the bottom of a price decline, just to avoid shorting stock. This means they miss out of half of all possible swing trades. When using options, you can buy a comparatively cheap put and get the same swing action with much lower risk.
  1. Options give you greater leverage. Because options require 5% to 10% of the cost of buying stock, you can use the same amount of money to control between 10 and 20 times the stock in swing trades. This means you can involve more stocks in the strategy and even expand your positions more through multiples of two or more options.
  1. Options allow you to diversify your swing trading strategy. By swing trading a higher number of stocks, you get more effective diversification, which further lowers your risk. The greatest problem in swing trading with stock is that diversification can become expensive and, thus, impractical.

You cannot get away from risk completely; and options are exceptionally complex vehicles for any activity. But if you are knowledgeable about the options market and you like the idea of swing trading, options deserve another look. Of course, you also need to be qualified by your broker to operate an options account.

By Michael Thomsett of ThomsettOptions.com

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