Once you decide to try your hand at swing trading, your next question is likely this:
“What kind of securities should I trade?” or “What are Options?”
If you’re looking for a security type with flexibility and built-in risk management, you might consider options trading.
Options trading is a little different from the usual approach of simply buying stock shares outright. This type of derivative offers the opportunity to stake a claim on shares at a specific price — but without the obligation to follow through on the full purchase if you choose not to.
Ready to learn more? Keep reading for some of the benefits of options trading for swing traders. Here’s your opportunity to gain a better understanding of this style of trading and decide whether it’s well suited to your personal style.
What Are Options?
First, let’s talk about what options actually are.
Options are a type of derivative … That’s a type of security that derives its value on an underlying asset. The derivative’s price can go up or down based on the underlying asset’s price.
Options aren’t the only kind of derivative. They’re a specific derivative where you have, well, options. By purchasing an options contract, you pay a premium or down payment, which gives you the right to purchase or sell a specific amount of the asset in question on or before a specific date.
With this contract in hand, you have the right, but not the obligation, to go through with the transaction. But if you choose not to go through with it, you don’t get that initial premium back.
There are two key types of options: call options and put options. In brief, here’s the difference…
- A call option gives you the right (but not obligation) to purchase a security at a specified price by a certain date.
- A put option gives you the right (but not obligation) to sell a security at a specified price by a certain date.
As a holder of a call or put option, you can buy or sell within the time period specified in the contract. On the expiration date, you can exercise the option or let it expire. At that point, it will lose its value.
It’s important to make a note here: Many traders don’t buy options with the intention of exercising them. Often, they buy the contracts so that they can then sell them for a higher price before the expiration date.
Like shares of a stock, options can be traded on OTC or major exchanges.
Benefits of Trading Options
Now that you have a basic understanding of options, why should you consider trading them? Here are some of the benefits of trading options for swing traders.
Flexibility
One of the main draws of swing trading is that it can offer flexibility. Options can offer even more flexibility. That may be part of why this trading style is so popular with swing traders.
Yes, you must put down a premium when trading options, but once you do that, you gain lots of flexibility in the trade. You have the option to sell the contract, to exercise the contract at the expiration date, or to dismiss the whole thing and call it a wash.
There’s no penalty in letting the options contract expire, other than the fact that you don’t get your premium back.
Options can also allow you to explore different asset types. Options can be contracts with stocks, but also with bonds, commodities, and foreign currencies.
As you can see, these parameters can give you many different paths to take with options. And you don’t have to slavishly follow every single tick of the stock. This means that if you have other life obligations, like a full-time job, you can still work with options without sacrificing a ton of time.
Managed Risk
Regardless of which trading style you pursue, there’s always an inherent level of risk. But one of the appealing aspects of options is that they can help you manage the overall risk in a trade and put a cap on your potential losses.
Yes, options do require that you put down a premium on your contract. This amount will go toward the trade if you decide to go through with it. If you decide not to, you won’t get that money back.
But then that amount also represents your total maximum loss. So even if the price action doesn’t go your way and you let the option expire, the premium is the largest amount you’d be out in this situation.
In contrast, if you purchase shares outright, your losses can be much bigger, whether you’re buying or selling.
With options, you can cap losses but still have trade potential. It’s almost like paying an insurance premium on your trade. Nope, you won’t get the premium back, but you can get some peace of mind.
Potential to Profit
Profits are never, ever a guarantee in trading. That said, there’s a potential for profit with options trading. How might that work?
Here’s an example. Let’s say you have a contract that gives you the option to purchase a stock at $20 per share. Now, let’s imagine that during the contract term the share price soars to $100 per share. If you exercise the option, you can still purchase those shares at $20 each.
At this point, you’re in an advantageous position…
You can turn around and sell the shares at the market price and make a significant profit. Of course, it’s important to note that this is completely a hypothetical situation — these results aren’t typical. Be sure to check your expectations as you trade options.
Are Options Right For You?
For swing traders, options can offer many benefits, including flexibility, a low initial cash output, and the ability to minimize losses.
Ultimately, only you can decide whether options are right for you. But if these benefits sound appealing, options trading might be a trading style worth pursuing on your swing trading journey!
SwingTrades With Paul Scolardi
I’m Paul Scolardi, a swing trader and the lead teacher at SwingTrades.
In my career, I’ve focused on being a forecaster of upcoming trends — rather than just looking at what’s happening in the market right this second.
Over the years, I’ve worked out a method of locating hot sectors and stocks by looking for earnings winners, sector leaders, and hot IPOs.
Intrigued? Consider joining my SwingTrades program!
Over 1,400 students from over 50 different countries have joined my program. As a teacher, I work to help them become self-sufficient traders by guiding them through the lessons I’ve learned through the years.
Don’t forget: Trading requires lots of hard work and dedication. No matter how much you study and prepare, there are always factors in the market that you can’t anticipate. Trades are always executed at your own risk.
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