1 Swing Trade Warrior Chapter 1. Introduction to swing trading and how to understand and use options
2 How does Swing Trading Work? The idea behind swing trading is to capitalize on short term moves of stocks in any direction over a period of time. As swing traders, we profit from trends and finding entry opportunities EARLY, before the crowds. (b/o and run vs. scalping) Swing trading is defined as: a speculative activity in financial markets where a tradable asset is held for between one to several days in an effort to profit from price changes or 'swings'. As traders, it is our job to identify trading opportunities that align with our risk parameters, evaluate trade candidates and execute trades with adherence to our rules and strategy. Like day trading, swing trades come from catalysts, events, technical setups and speculative opportunities.
3 What s the Difference? Both show a breakout right?
4 One Chart Was a Daily and the Other was a 5m Chart Which trade would you want to be in? Why? It depends on goals, risk, size etc.
5 Why do Most Traders Fail? Day trading requires quick decisions and a lot of discipline. Many new traders initially lack the ability to make good decisions and maintain composure while under the stress of a losing position, and even winning ones. The deer in the headlights! Skill and Discipline are like muscles that require exercise to grow. Your ability to make quick decisions and follow your trading rules will improve with experience and understanding. Swing trading can provide income and profits while one works to develop their day trading speed and build up their mental game. Swing trading can be emotionally easier when you are playing by the rules.
6 How Does Swing Trade Warrior Work? Watch lists, Alerts, Blotter and Trade Updates/Analysis
7 Options 101 Options can be difficult to understand, but are very effective when used appropriately People tend to see high % wins on options and fall in love losses can be high % also Options trades are for more speculative ideas as they rely on volatility in most cases For swing trading, I prefer the simpler uses for options, though, you can get as complicated as you want when trading spreads and multiple leg positions This section is just to give you a basic understanding of the options types that I use when swing trading, how and why There are 100s of complicated explanations for options, I will try to keep it as simple and relevant as possible. Most analogies attempt to explain exercise/assignment, which we will never do when swing trading.
8 Options provide financial leverage without needing to use borrowed capital. By investing in options, you can control a larger number of shares for the same initial investment, than if you purchased the shares themselves. Options contracts control 100 share lots of a stock. Cannot be purchased on margin! Cash only. For example, if you wish to invest $1 000 you could purchase 10 shares of ABC stock (hypothetically) valued at $100 per share. Alternatively, the option contracts may realistically be valued at $200 for lots of 100 shares ($2.00 per option). For your investment of $1 000, you could buy five options contracts, increasing your financial leverage by allowing you to control 500 shares instead of just 10.
9 The price (or cost) of an option is an amount of money known as the premium. An option buyer pays this premium to an option seller in exchange for the right granted by the option: the choice (the "option") to exercise the option or allow it to expire worthless The same concepts are at work here as when buying stock for every buyer, there must be a seller and therefore, liquidity. Two common ways to trade options: - Exercise vs. Assignment (Want to own stock) - Flipping them for premium (Want to profit in price changes/trade)
10 Options 101 Calls and Puts The two types of options are calls and puts (both control 100 shares of an underlying stock) A call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires. A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires. Participants in the Options Market There are four types of participants in options markets depending on the position they take: Buyers of calls (long/bullish on the stock) Sellers of calls (long stock covered calls, bearish on the stock) Buyers of puts (short/bearish on the stock/insurance/hedge) Sellers of puts (bullish on the stock/want to own stock below a certain price)
11 Story time! Just like in stock trading, for every buyer, there MUST be a seller!
12 Strike Price - The pre-agreed price per share at which stock may be bought or sold under the terms of an option contract. Some people refer to the strike price as the exercise price. In-The-Money (ITM) - For call options, this means the stock price is above the strike price. So if a call has a strike price of $50 and the stock is trading at $55, that option is in-the-money. For put options, it means the stock price is below the strike price. So if a put has a strike price of $50 and the stock is trading at $45, that option is in-the-money. Out-of-The-Money (OTM) - For call options, this means the stock price is below the strike price. For put options, this means the stock price is above the strike price. The price of out-of-the-money options consists entirely of time value. At-The-Money (ATM) - An option is at-the-money when the stock price is equal to the strike price. (Since the two values are rarely exactly equal, when purchasing options the strike price closest to the stock price is typically called the ATM strike. ) Intrinsic Value - The amount an option is in-the-money. Obviously, only in-the-money options have intrinsic value. Time Value - The part of an option price that is based on its time to expiration. If you subtract the amount of intrinsic value from an option price, you re left with the time value. If an option has no intrinsic value (i.e., it s out-of-the-money) its entire worth is based on time value. Time Decay Also known as theta, is the ratio of the change in an options premium price compared to the decrease in time to expiration. As options approach expiration, the time value declines. This is good for sellers/writers, but bad for buyers.
13 Exercise - This occurs when the owner of an option invokes the right embedded in the option contract. In layman s terms, it means the option owner buys or sells the underlying stock at the strike price, and requires the option seller to take the other side of the trade. We will rarely ever exercise options or hold them until expiration. We want to use options to profit quickly from short, strong moves by flipping the premium (buy low/sell high). Open Interest Open interest will tell you the total number of option contracts that are currently open. These are contracts that have been traded, but not yet liquidated by either an offsetting trade or exercise/assignment. When you buy or sell an option, the transaction needs to be entered as either an opening or a closing transaction. If you buy 10 of the MSFT March 27.5 calls, you are buying the calls to "open". That purchase will add 10 to the open interest figure. If you wanted to get out of the position, you would sell those same options to "close" and open interest would then fall by 10. Selling options as a writer will also add to the open interest. There is no way to determine if the open interest is reflecting bought or sold (written) calls. OI is used to help determine liquidity. Implied Volatility - The estimated volatility of a security's price. In general, implied volatility increases when the market is bearish and decreases when the market is bullish. This is due to the common belief that bearish markets are more risky than bullish markets. Implied volatility is sometimes referred to as "vols." IV will increase in the weeks before earnings, causing premiums to be more expensive than if the stock were trading at the same price during non earnings season.
14 Intrinsic Value and Time Value: The two components of options premiums The only options with intrinsic value, are those ITM Intrinsic Value (calls) = Underlying Price Strike Price Intrinsic Value (puts) = Strike Price Underlying Price Any premium in excess of the intrinsic value (ITM) is called time value Assume a call option has a total premium of $10 (buyer pays $10, seller receives $10 for each share of stock, or $1000 since the contract controls 100 shares) It the option has an intrinsic value of $8, its time value would be $2 ($10 - $8 = $2) Time Value = Option Premium Intrinsic Value Option Premium = Intrinsic Value + Time Value Why do you need to know this? It is critical to understand how premium pricing works so you understand what you are really paying for. Assume it is January, and that a call contract for an ATM strike price on a stock costs us $5 ($500) for a February expiration.. That same strike price for the same stock could cost us $7 ($700) for a March expiration. And $9 ($900) for an April expiration, etc. This is the effect time value has on options. In those cases, we are paying for time, the ability to hold the contract longer costs us more, because the potential for profit is greater over a longer period of time.
15 ITM, ATM, OTM, Strikes, Volume, OI, Premiums
16 Choosing the right strike using Volume, OI, time/expiry, and basic analytics We want liquidity because we find tighter spreads, and it is easier to get in and out of positions. Not all stocks have options, and not all stocks with options are liquid enough to trade reasonably. We want options at LEAST a month out to give the trade time to work, this will be more expensive b/c we are paying for time value We want a strike that will give us an optimal delta for profits as soon as possible (higher delta, means the options premium increases in value faster as the stock moves in our favor, more on this in a bit)
17 Using basic analytics can tell us about market sentiment. What are other people seeing and doing and where is the smart money going?
18 The Greeks, which ones do we care about and what are they? Δ(Delta) represents the rate of change between the option's price and the underlying asset's price - in other words, price sensitivity. Delta is the rate of change of the option premium for every $1.00 move in the stock price. Delta of.60 means that when ABC moves from $10 to $11, the options premium will increase from $1.00 to $1.60 or a rate of change of 60% Θ(Theta) represents the rate of change between an option portfolio and time, or time sensitivity (aka The Silent Killer ). Theta value is always negative for options b/c they are always losing time value. At time of expiration, all options will have 0 time value or extrinsic value. Theta represents the loss in premium value in options every day. Theta increases as expiration nears. If XYZ May $50 calls cost $3.50 and had a theta of -.20, for every day you own the XYZ May $50 calls, they will lose -.20 in value. Day 2, $3.30, Day 3, $3.10, etc. Γ(Gamma) represents the rate of change between an option portfolio's delta and the underlying asset's price - in other words, second-order time price sensitivity. This one is easy and we don t use it often. It tells how much delta will change when the stock price changes. Basically, how sensitive delta is to the stock prices movements. ϒ(Vega) represents the rate of change between an option portfolio's value and the underlying asset's volatility - in other words, sensitivity to volatility. Implied and historical volatility are more important when trading spreads, however, we need to be aware that Vega WILL influence our premium value. Have you ever bought a call option and had it lose money even though the stock price was moving in your favor? This is a result of the effects of volatility or Vega priced into the premiums. This is why we love using options on gap fills trades. And why buying options on volatile movers is all about timing. If we buy after a sharp move, we are buying inflated Vega and it will become harder to profit without a continued sharp move in our favor. Wait for the pullbacks! ρ (Rho) represents the rate of change between an option portfolio's value and the interest rate, or sensitivity to the interest rate. Important to know it exists, but for our swing strategies, and most options strategies, we don t really need to know much about Rho.
19 The Greeks are a necessary guide and can be helpful, but they are NOT ABSOLUTE They are constantly changing from one moment to the next as price, implied volatility, time and other factors affect the premium pricing
20 Basic options strategies Straddles ]x[: An options strategy with which the investor holds a position in both a call and put with the same strike price and expiration date. This happens when the investor believes that a stock s price will move significantly, but is unsure as to which direction (earnings, conference calls) The investor loses money if/when the stock trades flat or only moves a little in either direction. This trade is most profitable on volatile moves. Strangles [x]: An options strategy where the investor holds a position in both a call and put with different strike prices but with the same maturity and underlying asset. This option strategy is profitable only if there are large movements in the price of the underlying asset. This is usually cheaper than a straddle as the strikes are out of the money. We would use a strangle if we were more biased to one direction. A strangle allows us to guess the size of the move buy selecting our choice of OTM strikes for puts and calls. This trade is most profitable on volatile moves. Covered Calls: An options strategy where the investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This can be used to generate income when the stock is trading flat, or to offset the net cost of the stock in the event the trade goes against you. You collect premium from selling the call, and that reduces your average price of the stock. This is also known as a "buy-write". Example: If you own 100 shares of XYZ stock at $20 and sell 1 $25 call for $5, you now own 100 shares of XYZ stock for $15. (100 x $20 = -$2000 [your cost to own the shares]; $5.00 x 100 = $500 [you collect when writing the call]; -$ $500 = -$1500; $1500/100 = $15 per share
21 Use Covered Calls to cap profits and generate income
22 Major Breakout (anticipated): OTM Strike - Profits best on big breakouts - Risk less than At the Money or In the Money call, lower chance of success - Moves to (and through) high gamma as it becomes in ITM - Out of the Money call - Small delta ( ) - Leveraged Speculation play Slow Trend Play: ITM Strike - In the Money call - HIGH delta ( ) - Stock substitute play - Starts profiting right away - Profits well on small moves - Risk more than At the Money or Out of the Money calls, but significantly less than buying the stock - Low Theta (intrinsic value vs. extrinsic) Minor breakouts (anticipated): ATM Strike - Profits well on small breakouts (better R/R) - Risk more than using Out of the Money calls, but less than In the Money - Highest Gamma - At the money call - 50ish delta - Leveraged speculation play
23 When do we want to use options? When we want leverage without exposure (NFLX $440; 100 shares of NFLX is about $44,000, 1 at the money contract that controls 100 shares of NFLX is about or $14.00 x 100 = $1400) When we want to define our MAX risk (Risk/Max Loss is contained to the price we paid for our options) When we want to lower our net average cost on a long position or hedge to protect it to the downside When we want to generate income while a trade is flat When we want to trade a lotto play without exposing ourselves to unnecessary risk When we want to trade a volatile earnings/news play, but aren t sure what to expect
24 Options calculator
25 How to calculate your breakeven price when using options Before buying any call or put, you should know how to calculate your breakeven price in order determine profitability. Most brokers will do this automatically. Calls: Strike price + Option premium cost + Commission and any fees/transaction costs = breakeven price So, if buying June $50 calls on XYZ stock that sell for $2.50 (premium) and have a $20 commission, your breakeven is: $50 + $ = $52.70 per share (This means that to make a profit on this call option, the price per share of XYZ has to rise above $52.70) Puts: Strike price - Options Premium cost Commission and any fees/transaction costs = breakeven price So, if buying June $50 puts on XYZ stock that sell for $2.50 (premium) and have a $20 commission, your breakeven is: $50 - $ = $47.30 per share (This means that to make a profit on the put option, the price per share of XYZ has to fall below $47.30)
26 Options 101 Questions, comments, concerns? me: If you are so inclined, you can learn more about the complicated calculations that go into options premium pricing. The Black-Scholes Model is the grand daddy of options premium pricing.
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