Swing trading options is a great technique for beginners and advanced traders alike. The most common ways to swing trade options are naked calls and puts, credit spreads, and debit spreads. Traders look to buy a weekly contract for shorter-term swings and monthly expirations when trading a few weeks to a couple of months out.
Naked calls and puts are a directional strategy. So, you need the stock to move in the direction of your contract quickly to see a profit. The basics are simple. Purchase a call when the price rises and puts when the price falls.
Many traders like to swing trade options. It’s a very popular trading strategy. Typically, it involves buying and selling monthly contracts one to two months out. Still, each trader will decide whether to buy shorter or longer-term options contracts depending on their particular style and strategy. Most traders keep it simple; they do naked options or trade them with debit or credit spreads.
What Is Swing Trading Options? (Explained)
Day trading involves holding for less than a day, whereas with swing trading, you usually hold the option from at least overnight to as many days as it takes to hit your resistance zone (profit zone).
Sometimes, it takes a little longer than you want, and you must sell before option decay sets in. Then, it would be best if you had more time value. So, swing trading a naked call or put creates a race against time. Every day, the option trades sideways, and you lose a little of the contract’s value. When you get closer to the expiration date (the date the option contract ends), the time value drops faster and faster. Thus, the option “decays” more quickly.
A lot of people swing trade options because of the PDT rule. The PDT (pattern day trader) rule only lets you buy and sell a stock three times in 5 business days on the same day (day trades). You must have an account of $25,000 or more to avoid falling under this rule, which can be challenging for new traders just starting.
If you’re subject to the PDT rule, swing trading options can be incredibly helpful in circumventing that.
The Right But Not the Obligation
Options give you the right but not the obligation to buy or sell an asset at an agreed price in a certain amount of time. Most options traders want to trade options. They don’t want to own the stock. It’s just a game of hot potato. Swing trading options is a short-term strategy.
Now, most traders will only be comfortable sitting in the trade briefly. Usually, options traders want to make a profit within 3 to 5 days of purchasing the option. Swing trading usually plays on the short-term price action. It can be affected by earnings, news, and rumors. The longer you are in the trade, the riskier it gets. Plan your entry accordingly. The nice thing about swing trading options is that they let you trade with less capital and more leverage. You’re holding the premium for the right to buy 100 shares instead of paying the price to purchase 100 shares.
Swing Trading Options Example
Buying options with an expiration date several weeks out and deeper in the money is one of the more beneficial ways to make money because there is intrinsic value in the contract. For example, if I bought a $110 call on $AMD, and the stock trades at $117, I would have $7.00 of “intrinsic value.” There is also more time value if I purchase a few extra weeks.
Investors are usually willing to pay a higher premium price for a further-out expiration. It’s just “safer” and gives more breathing room for the trade to work out.
Just like in real life, time allows time to reach your goals.
Swing Trading Options Chart
You can monitor your call or put in an option by looking at the option chart. Looking at the stock chart is not enough for most options traders. If you’ve never seen a call or put chart, ask yourself why!? Then, ensure you get a platform that shows the candlestick chart of an option.
Is Swing Trading Options Less Risky?
One “call” options contract gives you control of 100 shares at a lower price than purchasing the actual shares. For example, if a stock is trading at $246 and you choose an option with an expiration date a week out, the strike price would be about $4.15. So $4.15 x 100 would be $415 that you’d risk. If you’re looking at it from the perspective of capital risk, it’s less risky than owning 100 shares.
Conversely, purchasing 100 shares of a stock at $246 would be $24,600. So you can see how you’d risk less capital by swing trading weekly options.
You’ll never lose more than the cost of purchasing the option, but you can lose it. So, while there is never a 100% risk-free way to trade, swing trading options is a way to define your risk and limit it.
You’ll have more money to make more trades because you risk $415 instead of $24,600. As a result, you’ll be able to diversify, which, in turn, also allows for less risk. Managing risk is one of the most important aspects of investing and trading.
Using Technicals Effectively
You probably hear people say, “Know your technicals” often when you’re getting into trading. People saying this may sound like a broken record. However, knowing candlestick patterns and price action is the most important aspect of trading to learn.
It all boils down to this. First, it helps you get better entry and exit targets. Getting a good entry allows you to stomach the pullbacks. Knowing support and resistance is incredibly important. Price action and other indicators are going to help you find these levels. This could mean the difference between winning and losing on trades. Swing trading options is a great way to make money once you know the direction in which a stock will potentially move.
If you believe a stock will go up and you buy a call without looking for support and resistance, you could buy that call at a resistance level and lose money.
Here’s a stock chart on $NFLX laying out simple supply and demand zones. Experienced options traders will review these zones before entering and exiting their trades.
Buy Low, Sell High Strategy
Keeping things simple is key with trading. Many traders overcomplicate things, but it comes down to one simple phrase. Buy low and sell high. That is why support and resistance are so important. If you buy a stock at support and it starts to rise, ensure you know where the resistance levels are. This could be the difference between a $500 or $1,000 profit, and even worse, a major loss if the price rejects and falls drastically.
What Is the Safest Option Strategy?
Credit spreads are the safest option strategy. Options sellers have much better win rates than options buyers. If you’re looking to be an options buyer, then debit spreads are a safer option strategy than buying naked calls and puts. The bottom line is, straight long call or long put aka naked options are more risky and have less of a chance of being profitable.
How Much Money Do You Need to Be a Swing Trader?
There isn’t a specific amount you need to be a swing trader, but having at least $5,000 to $10,000 in an account is a good target amount. The more money, the more leverage that you have to trade. This also prevents having to put too much capital into one trade. If you’re going to trade credit spreads, the more money the better, due to margin requirements per trade.
Avoiding Greed in Swing Trading Options
Green is always great when you swing trade options and see your gains. While your gains increase, you want to let your winners run. However, please be aware of supply and demand zones. Spot reversal zones before they happen, so you do not give back your profits. Many traders will take profits on the way up and hold a few contracts into the final resistance zone. This could be better than buying or selling all your contracts simultaneously.
You always want to cut your losses quickly and let your runners run. But you need to pay attention to what the technicals tell you instead of letting your emotions get in the way. Follow the trend. Also, make sure to practice paper trading options.
You can instantly watch your gains go from green to red when you get greedy and don’t take your profits. You never go broke taking a profit. Most important of all, make sure to use risk management strategies when swing trading options.
Frequently Asked Questions
Swing trading options allows investors to buy and sell contracts of an underlying security without having to invest large sums of capital.
- Buying naked options is the most profitable buying strategy
- Selling naked options is the most profitable options strategy overall, but also the most risky
- Debit spreads are a great directional strategy that helps to manage risk
- Credit spreads are the safest and least directional strategy
- Iron condors are the best range-bound strategy
Yes. Many start swinging options with small accounts, with less than $1,000. If you are patient, you can grow a small account over time. Credit spreads are among the best and safest ways to trade options and grow a small account. The gains will be smaller. However, growing a small account trading options takes patience and proper risk management. Day trading options limits you to the PDT rule and requires $25,000 to allow unlimited trading.
The 1% rule suggests that investors never invest more than 1% of their total capital into a single trade. In a $5,000 account, you shouldn't invest more than $500 on a single trade.
The 3 5 7 trading rule suggests limiting the risk on each trade to 3% of trading capital, limiting trade exposure to 5% among all trades, and making sure that winning trades have at least 7% more profit than losing trades.
