Swing trading is one of the most common methods for trading in the stock market. Whether you know it or not, you probably have already been swing trading all these while. Swing trading is buying now and then selling a few days or weeks later when costs are higher, or lower (in the case of a short). This kind of price increase or decrease is known as a “Price Swing”, hence the definition of “Swing Trading “.
Most beginners to options trading take up options as a form of leverage because of their swing trading. swing-trading.net They would like to buy call options when costs are low and then quickly sell them a few days or weeks later for a leveraged gain. Vice versa true for put options. However, many such beginners quickly discovered the hard way that in options swing trading, they may still make a considerable loss even though the stock eventually did move in the direction that they predicted.
How is that so? What are some problems related to swing trading using options that they didn’t pay attention to?
Indeed, although options may be used simply as leveraged substitution for trading the underlying stock, there are always a few things about options that a lot of beginners don’t take notice of.
1) Strike Price
It doesn’t take miss anyone to realize that there are lots of solutions across many strike charges for all optionable stocks. The obvious choice that beginners commonly make is to buy the “cheap” out from the money options for higher leverage. From the money choices are options which have no integrated value in them. They’re call options with strike prices higher compared to the prevailing stock price or put options with strike prices below the prevailing stock price.
The situation with buying out from the money options in swing trading is that even though the underlying stock move in the direction of your prediction (upwards for buying call options and downwards for buying put options), you might still lose ALL your money if the stock didn’t exceed the strike price of the options you got! That’s right, this is known as to “Expire Out Of The Money” helping to make most of the options you got worthless. This really is also how most beginners lose each of their profit options trading.
Generally speaking, the more out from the money the choices are, the higher the leverage and the higher the danger that those options will expire worthless, losing you all the amount of money put in them. The more in the amount of money the choices are, the lower more expensive they’re due to the value built into them, the lower the leverage becomes but the lower the danger of expiring worthless. You will need to take the expected magnitude of the move and the quantity of risk you can take into consideration when deciding which strike price to buy for swing trading with options. If you expect a big move, out from the money options would obviously offer you tremendous rewards if the move fails to exceed the strike price of the options by expiration, a nasty awakening awaits.
2) Expiration Date
Unlike swing trading with stocks which you can keep perpetually when things fail, options have a certain expiration date. This means that if you are wrong, you’ll quickly lose money when expiration arrives without the benefit of to be able to keep the positioning and await a reunite or dividend.
Yes, swing trading with options is fighting against time. The faster the stock moves, the more sure you are of profit. Good news is, all optionable stocks have options across many expiration months as well. Nearer month choices are cheaper and further month choices are more expensive. Therefore, if you are confident that the underlying stock is going to move quickly, you might trade with nearer expiration month options or what we call “Front Month Options”, which are cheaper and therefore have a greater leverage. If you wish to provide more hours for the stock to move, you might pick a further expiration month which will obviously be more expensive and therefore have a reduced leverage.
Therefore, the choice of expiration month for swing trading with options is basically a choice between leverage and time. Be aware that you could sell profitable options way before their expiration dates. Therefore, most swing traders choose options with 2 to 3 months left to expiration at least.
3) Extrinsic Value
Extrinsic value, or commonly referred to as “premium”, could be the part of the price of an option which goes away completely completely when expiration arrives. This is why out from the money options that individuals stated earlier expires worthless by expiration. Because their entire price consists only of Extrinsic Value and no integrated value (intrinsic value).
The one thing about extrinsic value is so it erodes under two conditions; By time and by Volatily crunch.
Eroding or extrinsic value with time as expiration approaches is known as “Time Decay “.The longer you hold an option that is not profitable, the cheaper the choice becomes and eventually it might become worthless. This is why swing trading with options is a competition against time. The faster the stock you select moves, the more sure of profit you are. It is unlike swing trading with the stock itself where you make a gain provided that it moves eventually, regardless of just how long it takes.
Eroding of extrinsic value once the “excitement” or “anticipation” on the stock drops is known as a “Volatility Crunch”. When an inventory is expected to make a significant move by an definite time as time goes on such as an earnings release or court verdict, implied volatility builds and options on that stock becomes more and more expensive. The excess cost built up through anticipation of such events erodes COMPLETELY once the function is announced and hits the wires. This is what volatility crunch is focused on and why a lot of beginners to options trading wanting to swing trade an inventory through its earnings release lose money. Yes, the extrinsic value erosion by volatility crunch can be so high that even though the stock did move powerfully in the predicted direction, you may not make any profit as the price move has been priced in to the extrinsic value itself.
Therefore, when swing trading with options, you’ll need to take into account a more complicated strategy when speculating on high volatility stocks or events and be able to choose stocks that move before the consequences of time decay has a big mouth full of the profit away.
4) Bid Ask Spread
The bid ask spread of options can be significantly larger compared to the bid ask spread of their underlying stock if the choices are not heavily traded. A sizable bid ask spread introduces an enormous upfront loss to the positioning especially for cheap out from the money options, putting you right into a significant loss from the comfort of the start. Therefore, it is imperative in options trading to trade options with a tight bid ask spread in order to ensure liquidity and a small upfront loss.