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Using Options for Swing Trading
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Using Options for Swing Trading

  #1 (permalink)
Hyde Park,
Chicago, Illinois
 
Futures Experience: Intermediate
Platform: Tradingview.com
Broker/Data: Optionhouse
Favorite Futures: Options
 
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Posts: 467 since May 2011
Thanks: 395 given, 252 received

Using Options for Swing Trading

Working on getting back in the trading arena and I have started brainstorming on what I want to do differently. I've dione a few hours of DD today and one question that has been on my mind for the past few weeks popped up again: How will I trade options?

I find that I can figure things out easier if I write them down so here are the pros and cons that I thought of when it comes to Bull/Bear Spreads vs Outright Purchases. Please correct me if I am wrong or if you can think of any other advantages/disadvantages:

Advantages of Spreads (Bull/Bear Spreads)
  • Managed risk: Nowadays there are a lot of traders who have experience and can accurately predict the market to the point that they should be profitable, but because they don't manage risk properly, they end up with a trading account in the red. Being able to define how much I will lose up front every time is a big plus.
  • Bid/Ask Spread is irrelevant: If I were trading outright calls/puts, I would have to ensure that the bid/ask spread is tight to avoid slippage and beginning the game too deep in the hole. With a spread though, this is irrelevant (I think?)
  • Volatility is irrelevant: Since spreads involve buying and selling, I won't ever have to worry about overpaying for an inflated option and I can participate regardless
  • I can do more with less capital: Since half of the spread is sold options, less capital overall is tied up. This works great for trading options with underlyings that are triple digits and/or move fast.

Disadvantages of Spreads (Bull/Bear Spreads)
  • Clashes with my trading timeframe: I want my trades to last between a day and two weeks. However, with bull/bear spreads, it is often about allowing time value to decay to lock in profit. The rate of decay increases as the option nears expiration but the further the option is from expiration, the slower it takes to get profits. If I trade an option that expires in 30 days to take advantage of a move that takes 3-4 days, I will be better of trading outright calls/puts. The work around I have decided to do is to use weeklies or front month options that are set to expire in two weeks or less. This leads to my next disadvantage though....
  • Greater commission costs: Having two legs or having more efficient capital usage means that I will be buying more contracts. More contracts = more fees. Fees are a big deal still since I don't have millions in my account.
  • Short term spreads limit what I can trade: Every stock doesn't have an option chain. Every optionable stock doesn't have weeklies. For the stocks that don't have weeklies, I would only be able to trade them two weeks out of every month. In addition to this, short term options will have little extrinsic value so I will have to trade volatile plays that can move 1-2 strikes in 1-2 weeks or else I will receive very little for the sold portion of the spread. Low price for sold portion of spread = no real reduction of risk. No reduction of risk means I might as well just trade an outright option
  • I can't hit home runs; only doubles and triples: "The worst mistake a trader can make is to miss a major profit opportunity. 95% of the profits come from only 5% of the trades” – Richard Dennis. Although aggressive bull/bear spreads can minimize what I leave on the table, it is impossible to knock a spread out of the park on a parabolic move because spreads don't participate in parabolic moves

Advantages of Outright Purchases
  • Profit potential is unlimited
  • More options to trade at my disposal
  • Less commission costs
Disadvantages of Outright Purchases
  • Risk is not as easily defined: I trade based on the underlying's pricing. The option that I trade however is derived by many things, one of which is the price of the underlying. There have been many occasions where the option has dropped in price even though the actual stock market price hasn't broken support/resistance.
  • I have to pay attention to the volatility and whether or not an option is inflated
  • I have to steer clear of illiquid options that have wide spreads

I have been going back and forth over what I want to trade in my head but now that I have it on paper, outright purchases seem slightly advantageous. The main disadvantage of outright trading is that I have to be more vigilant when it comes to risk management. This will be a focal point on my paper trading. The rest of the 'disadvantages' are not really setbacks, they are more like features that require further DD.

With bear/bull spreads, they severely limit what I can participate in because I wouldn't be able to use the tactic for a lot of underlyings that aren't volatile and won't have time premium with 1-2 weeks until expiration.

Solutions
  • Spreads might be ideal for the following:
  1. When volatility inflates options pricing so that it is more expensive than it should be historically
  2. When historical volatility is large because the underlying has been known to run ie: GOOG or AAPL
  3. When there looks like little chance of a home run: heavy support/resistance is nearby, market is choppy, etc. (or maybe I should just sit these out completely)
  4. Longer term trades (no plans to make this a part of my trading strategy in the near future either)
  • I could use outright options for everything else, making sure to control risk by:
  1. Set a sell-to-close contingent stop based on the underlying's price falling below anticipated support/resistance
  2. In addition to the sell-to-close stop listed above, I want to also always program a sell-to-close stop based on the option's price eroding 2% of my total portfolio value


Last edited by Bermudan Option; November 25th, 2012 at 11:39 PM.
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  #3 (permalink)
Trading Apprentice
Raleigh North carolina United States
 
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Debit Spread : Management


I think (feel free to disagree) the key to trading debit spreads is how you manage the trade. For example, if you placed a bull debit spread at-the-money and the market moves up----easy money! but what do you do when your wrong?

One idea is to turn the trade in to a skip strike butterfly. (This ups your margin requirement (alot) but lets you take in a credit to cover your losses on the original bull debit spread. In other words it "pays" for your "screw up" on the original trade. I would post a link to a page that explains it in more detail.... but Big Mike won't let me...I knew a "Big Mike" once...he was like 6'6- 350lbs....(and I'm not) so I'm cool with it.

This will have to do...

So if the trade started out:
Buy 1 Rut Dec 12 805 call at 14.80
Sell 1 Rut Dec 12 815 call at 9.50

If things go bad you would:

Sell another Rut Dec 12 815 call
buy Rut Dec 12 835 call

Do this when the credit you will take in will "cover" your losses.

You can also do a ratio butterfly- the margin requirements are less-

hope this helps

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  #4 (permalink)
Hyde Park,
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Futures Experience: Intermediate
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Posts: 467 since May 2011
Thanks: 395 given, 252 received

Thanks for the advice optiontrader767! Your post made me bust out my copy of Options As A Strategic Investment and reread the chapter on Butterflies. I have been thinking about the benefits of exiting positions completely vs hedging existing positions and so this added wood to the fire. Definitely an interesting idea.

The conclusion I have come to is that hedging risk to increase probability (aka buying myself extra time by selling time haha) is a useful strategy but it is kinda hard to tailor it to the way I trade and define risk.

I only want to risk risk a small preset percentage of my portfolio per trade, like 2%. At $10,000 this would equate to stopping myself out after losing $200 on a trade. I never anticipate losing everything invested in a trade. So although I might buy $3,000 worth of options I will force the exit after a 6-7% move against me.

Basically because of the way I trade, if the market moves against me, I cannot transition into a butterfly spread because margin requirements would tie up too much money (or more money than I have). If I traded smaller I could though, and I think I would do it like this:

I would tel myself that I will close out my Dec 12 RUT position if I go down $200 but I might tell myself to roll down or leg into a butterfly when I have $150 in losses to give myself extra time for the play to develop since it started out against me.

Rolling down might put my paper loss down from from $150 -> $100, thereby giving me more time for the underlying to become profitable before I lose $200 and stop myself out. It caps the profits greatly, but because of the way I define risk, I am playing with the house's money so to speak, because I would have closed the trade out had I been using the stock instead of the option.

I still need to do some research and DD on margin and the likes, but the wheels in my head are slowly churning

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  #5 (permalink)
Hyde Park,
Chicago, Illinois
 
Futures Experience: Intermediate
Platform: Tradingview.com
Broker/Data: Optionhouse
Favorite Futures: Options
 
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Posts: 467 since May 2011
Thanks: 395 given, 252 received

One week under my belt and my simulated account is in the hole 7. 5%. Sounds like crap but I am actually quite pleased with the results. I have learned a lot in the week.

(Note: I want to risk a max of $200 on each trade)
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ABX: Put a spread on but fucked it up and ended up being long when I wanted to be short (or short when I wanted to be long, can't remember) I made money on the play which sucks because I expect the market to got the opposite direction in the first place. Anyways, didn't manually close out the spread and I was long shares and didn't realize it. Gold was selling off and I got out but not without wiping out my initial profits and then some

FLS: This spread was put on properly but it was wrong directionally. I lost $150 and then paid $50 round trip in commission. Lost money but very very pleased with risk management. This trade is what made me finally decide to trade outright options.

YHOO: I saw weakness on the daily timeframe after the big run up from Marissa Mayer hype. The trend was higher on the longer term and I tried to fade the trend out of greed. Got stopped out and rightfully so.
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MSFT: Went short MSFT on break to a lower low on the shorter timeframe. The failed move lower led to a fast move higher and I was stopped out. I am not sure if there were any hints that the move lower would be short-lived, but if so, I certainly didn't look for it. Looking at the chart again, volume didn't give any clues intraday, but one thing I could have looked at was for the underlying to put in a lower high below resistance and/or stay below resistance for at least 30m - 1hr.
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SLW: I see what I did wrong and will work on noticing this in the future. After commission, I lost more than 2% my portfolio on this one after commission. Not a whole lot, but I want to be very tight with the stops.
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Still in this play:
APC: I liked how the chart was setting up, but it was Friday and I wanted to give the trade more than one trading session to go in my favor so I bought Weekly calls that expire Dec 14th.

I got into this trade early and almost paid dearly for it. I risked $10 per contract on this one and had lost $9/ct before the underlying went in the direction I expected.

This was my first runner and it made me realize that I had no gameplan in place for runners yet. During one point, I had $30 profit/ct. Since I risked $10/ct, that is 3x what I risked which is the target. Reaching this plateau, I should have taken some winnings off the table, but I did not and the market retraced.
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Currently sitting a $15 profit/ct. I will have to mull over what I want to do with this because there is a potential for some sideways potential before the market takes out the resistance overheard.
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Last edited by Bermudan Option; December 9th, 2012 at 08:07 PM.
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  #6 (permalink)
Hyde Park,
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Platform: Tradingview.com
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Flipped some CREE 34.5 weekly calls for a nice profit. Done for the day, had some losses yesterday so I am back where I started in terms of profit but man it felt good to flip

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  #7 (permalink)
Hyde Park,
Chicago, Illinois
 
Futures Experience: Intermediate
Platform: Tradingview.com
Broker/Data: Optionhouse
Favorite Futures: Options
 
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Posts: 467 since May 2011
Thanks: 395 given, 252 received

Trading live with two funded accounts now:

Regular Account:
10ct of HOV Jan $5.5
Entry: $0.95
Stop: $0.80

Lotto Account
75 ct of CIM Mar $3
Entry: $0.05
Stop: N/A

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  #8 (permalink)
Hyde Park,
Chicago, Illinois
 
Futures Experience: Intermediate
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Broker/Data: Optionhouse
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Posts: 467 since May 2011
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SPWR
Flipped this in the virtual account already but I like the way it has digested gains so far. Might make for a low risk entry in the near future. I don't think it will be ready tomorrow, but hopefully it will get near the resistance level by midweek and push higher after a small pullback:
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BAX
Strong uptrend for sure. Ascending triangle forming @ the top which I will look to play as an entry
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ACAS
Strong uptrend on the Daily although the chart selected is highlighting intraday action. I am hoping for a pullback on the 65m to retest it. If this happens, I will also use the support levels from Friday to create a stop:
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GM (Lotto Account)
Ford and GM are on a tear. With F however, the Doji into Friday's close is a little too scary for me, and the indicators point to overextended. GM started rallying later so hopefully it still has some gas in its tank.

Most indicators on GM, especially RSI, are in what I like to call 'hyper-mode' where it is stuck in Oversold territory so the potential for parabolic movement is there for sure. Since GM is such a large name though, there will hopefully be some obvious capitulation before it heads lower butI don't want to be holding the bag when the party is over so I am looking at some Feb 31s and holding for a move to @ least $32 but if the stars align right, a move to $35-$36 would be amazing. Looking to trade 25cts .
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  #9 (permalink)
Hyde Park,
Chicago, Illinois
 
Futures Experience: Intermediate
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Posts: 467 since May 2011
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Ok, here is what I am holding at the moment:
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Lost profits on CIM and F today. Established a position in MRVL hoping that it can keep its bullish momentum going.

Good luck everyone.

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  #10 (permalink)
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Stopped out of Ford and Marvel today. Still in CIM. Will try and do a more indepth analysis later today

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