Most swing traders use long stock for expected upswings; and either short stock for downswings or just stay out because shorting is high-risk and expensive. Two things are problematical with this idea. First, the risk is real, and second you miss half of the swing opportunities by avoiding going short.
There is a solution, and it enables you to trade with control of 100-share lots for much less cost than 100 shares. It also reduces market risk. Using options to swing trade is the perfect answer. Every option controls 100 shares of stock, so these are great ways to swing trade – and if you don’t like going short, you never have to by restricting activity to long options.
The chart of Chipotle reveals a repetitive pattern combining a reversal signal with confirmation. This is the ideal pattern for swing trading, because reversal with strong confirmation almost always precedes actual price movement in the direction expected.
The four repetitive patterns are:
- Early September began with a strong upside gap, a signal invariably followed by an adjustment closing all or part of the gap. This makes the upside gap an initial bearish signal. This was confirmed by the bearish candlestick signal, three inside down.
- Late October to early November saw a downside gap, which is a bullish signal. This was very strongly confirmed by the bullish doji star, anticipating a strong upward reversal.
- The beginning of December witnessed a three inside down, a bearish reversal signal. This was confirmed by a downside gap. However, once price gapped downward, the next likely move was assumed to be bullish. This occurred in the following set of signals.
- January began with a bullish engulfing signal at the bottom of the downtrend. This is one of the strongest and most reliable of candlestick reversals. After a delay, price once again gapped upward, confirming the bullish reversal. As always, the move upward was followed by a reversal that did not last long.
All of these patterns can be used to maximize the swing trade, and options can be used in many ways at such times. Following are five ways to swing trade with options:
- Long positions only. Buy long calls at the bottom and sell them at the top. Then buy long puts at the top and sell them at the bottom.
- Calls only. Buy calls at the bottom and sell at the top, and then open a short call and close it at the bottom. The exposed short call is high-risk, so this strategy is most appropriate when you also own shares of stock, making the short side covered.
- Puts only. Same idea, but in reverse. Buy long puts at the top of the swing and sell at the bottom. Then sell short at the bottom and close at the top.
- Calls and puts together. You can double up the swing by opening both bullish and bearish positions. This consists of a long call and short put at the bottom, and a long put and short call at the top. These positions, also called “synthetic stock” if using the same strike, double your potential income (but also exposes you to more risk). The advantage is that with both a long and a short, you have little or no net cost to open a position.
- Short options only. Finally, use only short positions. The big advantage here is that you always receive money and never pay to open a position. The disadvantage is that this is a high-risk approach. In the short-only method, you open a short call at the top of the swing and then close at the bottom; and you open a short put at the bottom and close it at the top. This high risk can be converted to a conservative strategy if you own shares. Positions like the covered call, covered straddle or short strangle (with call side covered) yield immediate income but all are conservative. With the short side only, it is wise to focus on extremely short-term expirations of two to four weeks. This maximizes time decay while keeping exposure time at a minimum.
The key to successful swing trading is in your ability to recognize reversal signals from price patterns, volume, candlesticks, and momentum oscillators. However, even the best signal should be acted on only when you also find confirmation. Even then, there is no such thing as 100% success, but the confirmation method vastly improves your timing for both entry and exit.