Course Category

Leverage limitations in swing trding with stock

Problems with diversification in stock-based strategies and limits on portfolio expansion to more than a few issues on which to swing trade; capital limits mean that only a minor number of issues can be swing traded at any given time; this limits the opportunity even when entry timing is ideal.

Options as solutions to the risk and leverage issues

Features of options include high leverage, which facilitates diversification by swing trading on numerous issues; options further reduce swing trading risks by limiting exposure to the cost of options; and by allowing for elimination of stock shorting through the use of long puts.

The power of options close to expiration

Most option strategies call for time to expiration; options used in long swing trades are most advantageous when within less than one month from expiration, because time value is minor or non-existent; thus, intrinsic movement is closer than ever to 1-to-1 with the underlying security.

Spotting reversals in the swing trading strategy

The best-known swing trading reversal signals are the narrow range day (NRD), the reversal day, and the volume spike. Additional signals include the reversal price gap and exceptionally broad range days. This section further introduces the strongest reversal signals found in candlestick charts, including single, two-day, and three-day formations; this section also demonstrates how candlestick reversal signals can serve as valuable confirmation of other entry and exit flags.

The long/short call strategy, uncovered short side

The use of calls alone combines low risk (long call) and high risk (uncovered short call). When both long and short calls are used, the cost of long calls is offset by premium received for short calls. Confidence in downtrend reversals must be exceptionally high to justify uncovered call risks. This risk is reduced considerably when the short call entry is timed to coincide with high implied volatility.

The long/short call strategy, covered short side

The risk of the long/short call strategy is eliminated entirely when the short side is a covered call. In this strategy, the trader owns 100 shares of the underlying for each short call position opened. The uncovered call risk is non-existent in this approach. If the short call is exercised, shares are called away at a profit; the trader earns dividends and keeps option premium received. On the uptrend reversal side, the long call functions in the same manner as other long option swing trading strategies

The long/short strategy, ratio writing on the short side

Yet another variation is creating a ratio write on the short call side. For example, the trader owns 300 shares of the underlying, but at the entry point for downtrends, sells four calls, creating a 4-to-3 ratio write. This section examines the many variables of ratio writing and demonstrates that as part of a swing trading strategy, ratio writing does not add substantially to the risk exposure of the short call.

The long/short put strategy

This strategy involves buying long puts at the top of the uptrend in anticipation of a downtrend reversal; and selling an uncovered put at the bottom in anticipation of a reversal and uptrend. The short put used at the bottom of the swing represents a risk; if the underlying continues its decline, the short put will be exercised and 100 shares put to the trader. This can be avoided by closing or rolling the position. Or exercise can be accepted, and then reverting to strategy # 8 (long call with covered short call).

The short option strategy

This variation involves short calls and puts. Short calls are entered at the top of the uptrend when a reversal is signaled; and short puts are used at the bottom. Both sides may be uncovered or the short call may be covered by ownership of 100 shares for each call sold.

Synthetic option positions strategies

A particular form of option straddle is opened employing the same number of calls and puts. The calls are long and the puts are short (synthetic long stock), and this is entered at the bottom of a downtrend. The synthetic position mirrors change in the stock’s price as it moves upward, but the cost of the straddle is minor and may even net to a credit. Or the calls are short and the puts are long (synthetic short stock). This is entered at the top of the swing in expectation of a reversal and downtrend. The synthetic position mirrors movement in the underlying, but has little or no net cost, and possibly a net credit. Synthetic positions are lower risk than owning stock and also are lower risk than using long option contracts.

Multiple contracts and one-side weighting strategies

Swing trades do not have to consist of equal weight on one side or the other. When traders believe movement in one direction is more likely than in the other, that reversal may be weighted with more than a single contract, or with a weighted synthetic position. This last section demonstrates the flexibility of swing trading with options, and demonstrates the low-risk, leveraged advantage trades accomplish using options rather than stock.