Options for swing trading leverage and low risk to maximize short term trading

Options for Swing Trading Options for Swing Trading Leverage and Low Risk to Maximize Short-Term Trading MICHAEL C THOMSETT OPTIONS FOR SWING TRADING Copyright © Michael C Thomsett, 2013 All rights reserved First published in 2013 by PALGRAVE MACMILLAN® in the United States— a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010 Where this book is distributed in the UK, Europe and the rest of the world, this is by Palgrave Macmillan, a division of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries ISBN 978-1-137-34411-3 (eBook) ISBN 978-1-137-28256-9 DOI 10.1057/9781137344113 Library of Congress Cataloging-in-Publication Data Thomsett, Michael C Options for swing trading : leverage and low risk to maximize short-term trading / Michael C Thomsett pages cm Includes bibliographical references and index ISBN 978–1–137–28256–9 (alk paper) Stock options Speculation Investments I Title HG6042.T46165 2013 332.64—dc23 2013001692 A catalogue record of the book is available from the British Library Design by Newgen KnowledgeWorks (P) Ltd., Chennai, India First edition: September 2013 10 Contents Acknowledgments Introduction: Problems of Risk in Most Trading Systems Options: Trading Basics vii Swing Trading: The Basics 27 Dangerous Waters: Risk Inherent in Comprehensive Swing-Based Strategies 61 Marginal Potential: Leverage Limitations in Swing Trading with Stock 75 Elegant Solutions: Options to Address the Risk and Leverage Issues 85 In and Out: Entry and Exit Criteria for Swing Trading 99 Powerful Timing Tools: Expanding Swing Signals with Candlestick Reversals 133 Flexing Your Muscle: The Power of Options Close to Expiration 165 Swings Maximized: Timing the Swing with Ex-dividend Date 179 10 Strategy # 1: Long-Option Approach, a Basic Solution 193 11 Strategy # 2: Long/Short-Call Strategy, Uncovered Short Side 213 vi Contents 12 Strategy # 3: Long/Short-Call Strategy, Covered Short Side 227 13 Strategy # 4: Long/Short-Call Strategy, Ratio Writing on the Short Side 245 14 Strategy # 5: Long/Short-Put Strategy 267 15 Strategy # 6: Short-Option Strategy 281 16 Strategy # 7: Synthetic Option Positions Strategy 295 17 Strategy # 8: Multiple Contracts and Weighting with Ratio Calendar Spreads 307 18 Strategy # 9: Expanded Iron Butterfly Swing Trading 327 Epilogue—The Big Picture: Swing Trading and Your Portfolio 339 Notes 347 Bibliography 349 Index 351 Acknowledgments I extend my thanks to the numerous individuals who responded to my articles and blog posts on LinkedIn, Twitter, SeekingAlpha, and CBOE on topics found in expanded form in this book Your observations, questions, and criticisms were appreciated Also, thanks to the management of StockCharts.com for allowing the free use of their charts in this book The publishing and editorial staff at Palgrave Macmillan deserve special acknowledgement for their professionalism, enthusiasm, and dedication to creation of high-quality projects, with special thanks to Laurie Harting, Lauren LoPinto, and Joel Breuklander Finally, my deep gratitude to my agent, John Willig, for his energetic and unfailing optimism and belief in this and my other publishing projects Introduction: Problems of Risk in Most Trading Systems It is living and ceasing to live that are imaginary solutions André Breton, Manifesto of Surrealism, 1924 Traders never stop looking for the PERFECT system, the one that creates profits in every trade and never yields the nasty surprise of loss This perfect system is the sure thing And even though everyone knows it doesn’t exist, the search never stops If such a system could be found, the entire premise of the market would be destroyed as well What drives trading, after all, is the idea that it is possible to improve the odds and overcome the typical outcome through a few attributes: improved timing of entry and exit, reversal recognition, strong confirmation, and the ability to act rationally and contrary to the emotional herd mentality of the market This is where swing trading comes into play Many names have been given to swing strategies A related strategy, day trading, ended up with a very negative reputation due to excesses and large losses Today, automated systems of high-frequency trading (HFT) are controversial and are blamed for market fluctuations In this system, automated trading takes place in a matter of seconds, reaping a small benefit on millions of shares HFT accounts for a majority of all trades each day: For years, high-frequency trading firms have operated in the shadows, often far from Wall Street, trading stocks at warp Options for Swing Trading speed and reaping billions while criticism rose that they were damaging markets and hurting ordinary investors Now they are stepping into the light to buff their image with regulators, the public, and other investors After quietly growing to account for about 60 percent of the seven billion shares that change hands daily on United States stock markets, the firms are trying to stave off the regulators who are proposing to curb their activities.1 Does the practice of rapidly moving in and out of positions truly create adverse effects in the market? It’s true that those large institutions applying algorithmic methods to move in and out of positions are profiting It’s also true that they exploit the system to get these profits But the extent to which this harms retail investors is far less certain The fact that the practice of rapid trades does create profits doesn’t have to mean someone else loses That’s not how the market works Swing trading, for example, is a much slower version of HFT, in which an individual moves in and out of positions in three to five days (typically), using timing techniques to exploit exaggerated price movement and then exiting with small but frequent profits The question is whether this practice harms other, longer-term buy-and-hold positions How does a rapid in-and-out trading system create any damage to others? In the auction market, buyers and sellers transact shares by arriving at a meeting of the minds about value Trades occur when both sides agree on the price of shares So whether you are in a position for three days or three years (or three seconds), the price you pay or receive is part of that auction market The idea that one trader’s profits have to come at another trader’s loss is simply unsupported Swing trading is a system for acting on price changes Swing traders expect large but sudden price movement to be exaggerated, which means that it will usually self-correct within three to five trading sessions When a trade is entered into on this premise, it’s a response to price movement created by other traders So if a stock price falls four points, it Introduction means many other traders wanted to dispose of shares, and that selling demand drove the price down If you pick up shares after the four-point drop and prices later rise, you profit It’s true that the initial sellers lose as a consequence, but they willingly sold their shares The market’s price movements occur for good reasons Sellers decide to sell in the belief that the current price is better than it will be later, and buyers buy in the belief that the current price is a bargain This is a simple reality of supply and demand in the market If a trader artificially creates the illusion of changes in value, that’s cheating So for example, a “pump and dump” is an action meant to drive up the price of a stock after buying it, hoping that shares can be sold at a profit once others respond to the hype: “Pump and dump” schemes, also known as “hype and dump manipulation,” involve the touting of a company’s stock (typically microcap companies) through false and misleading statements to the marketplace After pumping the stock, fraudsters make huge profits by selling their cheap stock into the market “Pump-and-dump” schemes often occur on the Internet where it is common to see messages posted that urge readers to buy a stock quickly or to sell before the price goes down, or a telemarketer will call using the same sort of pitch Often the promoters will claim to have “inside” information about an impending development or to use an “infallible” combination of economic and stock market data to pick stocks In reality, they may be company insiders or paid promoters who stand to gain by selling their shares after the stock price is “pumped” up by the buying frenzy they create Once these fraudsters “dump” their shares and stop hyping the stock, the price typically falls, and investors lose their money.2 However, swing trading based only on observed price movement, trend reversal signals, and confirmation is an appropriate method for timing trades and by no means a manipulation of prices The pump-and-dump technique is fraud, but there is no fraud .. .Options for Swing Trading Options for Swing Trading Leverage and Low Risk to Maximize Short-Term Trading MICHAEL C THOMSETT OPTIONS FOR SWING TRADING Copyright © Michael... in Swing Trading with Stock 75 Elegant Solutions: Options to Address the Risk and Leverage Issues 85 In and Out: Entry and Exit Criteria for Swing Trading 99 Powerful Timing Tools: Expanding Swing. .. Data Thomsett, Michael C Options for swing trading : leverage and low risk to maximize short-term trading / Michael C Thomsett pages cm Includes bibliographical references and index ISBN 978–1–137–28256–9