Swing Trading in Options – Concept, Working, Examples & more

In this article we look at the execution of swing trading in options.

Like most other form of trading, swing trading can be adopted for various types of securities. This ranges from stocks, futures, options, commodities, forex, cryptocurrency etc.

The swing trading strategy may need modification depending on the type of securities traded.

About Swing Trading in Options

To understand how swing trading in options work, we must first understand what are options and how they are traded. Options are the derivative form of securities trading.

It is a financial contract that gives the holder an ‘option’ to buy or sell a specified quantity of a security on or before a specified date at a specific price.

There are primarily two types of options:

Call option

Gives the buyer of the option the choice to buy. The seller of the call option is obligated to sell if the buyer so exercises.

Put option

Gives the buyer of the option the choice to sell. The seller of the put option is obligated to buy the sold security, if the buyer of the put option so exercises.

Options are derivative contracts as they are settled without actual delivery of the security.

If the contract is exercised by the buyer of the option, it is settled by payment/receipt of the difference between the options price and the market price of the security on the exercise date.

Option traders typically enter into several option contracts simultaneously.

They often seek opportunities to enter into opposite call and put transactions for the same stock so as to assure squaring off with a profit.

Specific features of options contracts exist that make them amenable to swing trading –

1. Risk and losses are limited
2. Correct entry timing creates high profit potential

All in all, you can look for quantum profits in options as compared to plain stocks while keeping the losses limited.

They are limited to the price paid (premium) to acquire the options contract.

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How to Swing Trade Options?

Options contracts are also amenable to swing trading. Let’s look at how swing traders can execute swing trades in options:

Identify Asset Class

The first to successful swing trading is to pick the asset class in which the swing traders should take positions.

A swing trader should look out for an asset class which in his view is likely to present a profitable trading opportunity. He can choose among several types such as stocks, commodities etc.

Ideally those securities are sought out for which a price retracement is likely which can present a profit-making opportunity for a swing trade.

Using momentum indicators such as RSI can be useful here. Once the swing trader has zeroed in on asset class, he can create a watchlist of securities with the class.

This can aid to track their prices and gauge price trends to structure trades within.

Type of Option

The next step is to select the type of option to trade in. This could either be a call option or a put option.

This selection primarily depends on your outlook of the price movements in the market and especially for the selected securities.

If the swing trader has a bullish outlook on the market, he should opt for purchasing a call option. In this way he can exercise the option when the prices rise and peak and book a profit.

On the flipside if the swing trader has a bearish outlook of the market, he should opt for purchasing a put option. Here he can exercise the option when the prices begin to fall and hit lows and book a profit.

After selection of the type of security and the type of option, swing traders appropriately choose the financial parameters of the options contract.

This ensures determining the strike price and the period of the future contract.

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Strike Price

Strike price is the price that applies if the trader executes the options contract.  This is an essential step as it determines the quantum of profit that the swing trader can make.

The relation between the strike price and current market price determines the cost of a future.

The better the strike price in comparison to the current market price, the higher the premium paid for the options contract.

When the difference between the strike price and current price is negligible the option is called ‘at the money’ (ATM).

When the strike price is far better than the current market price, the options contract is ‘in the money’ (ITM).

On the flipside when the strike price is significantly less attractive as compared to the current market price, the options contract is said to be ‘out of the money’ (OTM).

As swing trading is a short-term trading strategy, swing traders should look for options contracts that are currently available at OTM level but which they envisage can turn ITM in a short period of a few days or few weeks.

Period of Options Contract

The period of the options contract is another factor that determines its cost. The period of the contract ends when it reaches its ‘expiration date’.

The further away the expiration date the higher will be the cost of the option. Swing traders should select their expiration date based on their forecast of the price trend.

If the swing trader chooses an expiration that is too near, the price trend may not get an opportunity to turn profitable resulting in a loss for the swing trader.

If they however choose an expiration date which is too far, the cost of the options contract may be too substantial. Generally swing traders choose expiration dates of around a month.

Determine Entry Point

Swing traders use various technical analysis coupled with swing trading indicators to identify and act on price trends.

Swing trading in options rely specifically on the RSI indicator as its prime objective is to identify turns in price trends.

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Examples of Swing Trading in Options Contracts

There are two primary ways in which a swing trader looks to profit:

Through exercise of options contracts on or before expiration

This is the conventional way of making profits through options contracts. E.g.- A swing trader buys a call option in stock A at an exercise price of INR 50.

He envisions that the price is on an upward trajectory. Within a week, the price jumps 10% and reached INR 55. The swing trader exercises his call option and earns a profit of INR 5 per unit.

Traders buy options contracts in lots. Hence INR 5 is his profit multiple for all the units in the lot.

Through selling their options contracts before expiration

This is the way in which most swing traders actually attempt to maximize their profits.

This occurs when the swing trader has a strong forecast of a significant price swing. E.g. – A swing trader believes that the price of stock B is severely overpriced.

He also believes that its price will crash. Its current market price is INR 100. He enters into a put option at INR 70. Since the option is OTM, its premium is extremely low say INR 0.5.

As predicted, the stock crashes over the next few days falling to INR 72. Although the contract is not yet ITM, its strike price is now attractive and now the same put contract sells at a cost of INR 3.

If the swing trader has purchased 10,000 lots, he can quickly book a profit of INR 25,000 by selling his options contracts bought at INR 0.5 at INR 3.

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Swing Trading in Options – Conclusion

Swing trading in options can be more profitable than swing trading in stocks – as profit potential is high with a limited risk exposure, making this a popular choice for swing traders.

Gaining an in-depth understanding of price trends and volatility levels in the market can you help you execute a better and more profitable swing trade in options.

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