Most swing traders use long stock for expected upswings; and either short stock for downswings or just stay out because shorting is high-risk. Two things are problematical with this idea. First, the risk should not be ignored; 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 trading 100 shares, as low of 3 to 5 percent. It also reduces market risk. Using options to swing trade is a logical answer, assuming you have the knowledge of trading rules and risks associated with options trading. Every option controls 100 shares of stock, and these are many ways to swing trade — and if you don’t like going short, you never have to with long options.
Here 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. Despite the commonly cited statistics that 75% of options expire worthless, it is not as dire. In truth, only 75% of options held to expiration expire worthless. Most are closed early. Only about 10 to 15 percent of options are held to expiration without being closed on the last trading day. So the long option is not as much of a troubling trade as many believe. If you time your entry with the price swing and rely on strong reversal signals, long positions can outperform the market.
- Use calls only.Buy calls at the bottom and sell at the top, and then open a short call and close it at the bottom. Uncovered calls are risky, but this risk can be mitigated if you also own 100 shares. Risk is further reduced based on the strength of reversal signals, time remaining until expiration, and selection of a strike. By timing the entry in a short call with the trading pattern, you reduce this market risk significantly.
- Use 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. Uncovered puts are not high-risk, and they have the same market risk as covered calls. This makes the put a very desirable trade.
- Use both calls and put.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 and expiration, 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.
- 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 with the short call, unless it is covered. 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. As with every form of swing trading, you need to rely on strong reversal signals to time entry and exit.