Stock options are limited duration contracts that grant option buyers the right to sell or buy a stock at a predetermined price. On the other hand, the option sellers/writers are the ones who give the buying or selling right to the option buyers. Traders often swing trade options as substitutes for the stocks. Swing trading options is among the most profitable trading assets but also presents several risks.
Each stock option represents about 100 stock shares. Options swing traders use the call option to purchase 100 shares of a particular stock. In that case, the buyer acquires a limited-time right to buy 100 stock shares from the option seller or grantor at a predetermined price known as the strike price. On the contrary, a put option is used to sell the 100 stock shares. The put buyer acquires the selling right of 100 stock shares at an agreed strike price.
Swing trading options can be complex, particularly for beginners. That being the case, we’ve prepared this guide to help those interested in swing trading options to master some crucial things about this approach.
What is Swing Trading Strategy?
Swing trading involves holding trades for a couple of days, weeks, or months, aiming to generate profit from an expected price move. We have an article focused on choosing stocks for swing trading, this article deals with swing trading options strategies.
What is Swing Trading Options?
Swing trading with options involves traders exploiting short- and medium-term stock shocks, notwithstanding the range or depth. A specific stock that faces a relatively small volatility can still have its options value skyrocket.
How to Swing Trade Options
Swing trading in options can be complex, especially if you don’t understand the basics. The following steps can help you master swing trading options strategies, including things you should do to successfully swing trade with options.
Step 1: Choose an Asset
When swing trading with options, the first step is to identify the asset you will trade. Options swing traders often track multiple asset markets to have a more comprehensive view and select the most appropriate market.
When choosing an asset, use momentum indicators like the Relative Strength Index (RSI). These indicators help you determine whether the asset’s market is oversold (below 30) or overbought (above 70). Using such technical or fundamental analysis tools can help you predict price movements better.
Step 2: Select a Direction
You are now ready to take a directional market perspective upon identifying a suitable market to swing trade options using your preferred analysis technique. Suppose you think the asset market will rise. In that case, you will use the call option. This way, you’ll go long on the underlying asset you wish to trade with reduced downside risk and unrestricted upside potential.
Alternatively, if your view is that the market will fall, you’ll purchase a put option and go short on the asset. Doing so limits downside risks while opening a limitless upside potential.
Step 3: Choose a Strike Price
An option’s strike price plays a vital role in helping to determine its price. Generally, the more appealing an option’s strike price is compared to the current market price, the higher it costs. Additionally, the farther the strike price is from the expiration date, the costlier it gets.
When the strike price is higher than the current market, it is ITM or “in the money.” A stock option whose strike price is in the money is known to have “intrinsic value.” Intrinsic value is the difference between the strike price and the prevailing market price.
On the other hand, if the strike price of an option is equivalent to the current market price, it is said to be at the money (ATM). When it is lower than the current market prices, it is out of the money (OTM). OTM and ATM options do not have intrinsic value.
Most options swing traders often trade OTM options. This is because they expect them to go ITM quickly to sell them after a relatively short period.
Step 4: Select an Expiration Date
Selecting an expiry date depends on how long a trader thinks it will take for the market price to match their objective. Therefore, if you think it will take longer, trade with long-term options. Similarly, select a short-term expiration date if you think the market price will reach your goal faster.
Step 5: Perfectly Time Your Entry
Timing your trade entry point is one of the crucial success factors when swing trading with options. Whether you’re swing trading futures, ETFs, or options, use technical analysis tools to time your entry. These tools help you identify prevailing trends, enabling you to predict the possible future movement and place your trade accordingly.
Step 6: Execute and Manage Your Trade Position
Once you decide when to enter a trade, it’s time to execute your trade as per your trading plan. You can buy considerably on the money (OTM) swing trading call options when the general trend is higher or use the put option when the trend moves downwards.
Once you execute a trade, your investment is at risk of loss. That said, you need to monitor the underlying asset’s market and manage your swing trading option accordingly.
Tip: Where you trade options is equivalently important as how you trade them. Therefore, you should always choose a reputable broker to avoid losing your investments to scammers.
Look at our list of suitable brokers that trades options.
Best Indicators for Swing Trading Options
Swing trading options requires traders to use technical analysis tools and indicators to determine when to enter a trade. Here are some commonly used swing trading indicators.
Bollinger Bands
When swing trading options, volatility is a crucial factor. Option traders use Bollinger Bands to measure an option’s volatility. When volatility increases, the bands expand, and as it decreases, they contract. If the security price moves closer to the upper band, it implies that it is overbought. On the contrary, if the price moves towards the lower band, the security is highly overbought.
Relative Strength Index (RSI)
RSI is an indicator used to measure momentum. It compares the extent of recent losses or gains over a particular period and the speed of changes in price actions. This helps to determine oversold and overbought situations.
RSI numbers range from 0 to 100, with any value below 30 being considered as oversold. On the contrary, if the value is beyond 70, it indicates an overbought level. The figure below shows how RSI looks like:
Put-Call Ratio (PCR)
The put-call ratio computes the security’s trading volume by comparing put options and call options. Changes in the put-call ratio imply a change in the general market sentiment. If the ratio is beyond 1 (higher puts than calls), it indicates bearishness. On the other hand, if the PCR is below 1, it indicates bullishness.
Options Vs Futures
People tend to confuse options and futures contracts. This is because the two have several similarities. For instance, they allow investors to purchase an investment at a future at a specified date and price. However, options and futures contracts differ widely in various aspects.
For example, options contracts give the trader a right (and not obligation) to sell or buy assets at a specified price at any period within the duration of the contract. On the other hand, futures contracts require buyers to purchase assets and sellers to sell them on a specified future date, except if the holders’ position is closed earlier than the expiration date.
In futures trading, the buyer or seller has an obligation to buy or deliver a specific asset before the closing of the holder’s position.
The following are some examples of assets that options are applied:
Stock Options Trading
Stock options contracts represent 100 shares of an underlying stock. Swing traders benefit from call options when the stocks’ market price is above the strike price. On the other hand, they profit from put options when the stocks’ market price is below the strike price. This is because they can sell their stock at an increased price.
Options Trading Forex
Forex options are defined as derivatives centered on an underlying currency pair. Forex options trading require traders to adopt various strategies depending on the options selected and the brokerage system.
Options traded in forex markets differ significantly from those trades in other asset markets. This is because they enable swing traders to transact without receiving the actual asset delivery. Traders can trade forex options over the counter and are responsible for selecting expiration dates and strike prices.
Crypto Options Trading
The present crypto options market is significantly dictated by institutions. However, retail swing traders are starting to join the party. Purchasing crypto options offer traders comparatively low-risk and low-cost cryptocurrency trading solutions than crypto futures.
There are 2 crypto options styles:
- European style.The buyer is only allowed to exercise a contract when the expiration date is approaching.
- American style.The buyer exercises the options contract at any given time before the expiration date.
Although the European style options are exercised on the expiration date, it can also be sold to somebody else if the buyer chooses to. The cost of a crypto option is known as premium.
Suppose a trader wants to purchase a crypto call option with a lower strike price than the underlying asset’s current price. In that case, they will pay a higher price for this options contract because the contract is ITM and has an intrinsic value.
Options Swing Trading FAQ
Can We Do Swing Trading in Options?
Yes. You can do swing trading using options profitably as long as you understand basic concepts, adopt the right strategies and the best indicators.
Which is the Best Book on Swing Trading?
There are many books on swing trading. One of the best books that can guide you on swing trading is “Mastering the Trade: Proven Techniques for Profiting from Intraday and Swing Trading Setups.” The book’s author is John Carter. John himself is recognized as one of the most prosperous traders the world has ever had.
As of October 2021, the book had an average rating of 4.7 out of 5 on Amazon. This rating is generated from more than 450 buyers.
Is Options Trading Better Than Stocks?
People often ask whether trading options are better and more profitable than stocks. Options trading is riskier than stocks trading. However, when done correctly, it can have better profitability than traditional stocks trading.
How to Make Money with Swing Trading Options
Options swing traders make cash by being option writers or option buyers. Suppose you’re the buyer of a stock option (call option). In that case, you gain money if the underlying asset increases beyond the strike price before the expiry date.
On the other hand, if you’re a put options buyer, you will profit if an underlying stock price goes below your chosen strike price before the selected expiration date.
Closing Thoughts
Swing trading options is a risky affair. However, you can make significant profits if you follow the right steps and use appropriate technical indicators. Before selecting your go-to options broker, always perform a market analysis to find and validate their authenticity and cost-effectiveness. This way, you can identify a broker whose platform best suits your options trading goals.
