#Trading: Swing Trading Stocks using the leverage of Options

Disclaimer: I am not a certified financial planner or financial adviser.The information provided should not be used as financial advise, it is used to promote financial literacy and discussion. The views and opinions on this site are my own. Any suggestions or investment advice should be reviewed by a financial professional before acting on them.

I have tried my hand at swing trading stocks but with limited capital I was severely restricted in the amount of profit I could make. My capital is limited to less than $5000. I trade 500-2000 shares with the goal of capturing $0.25-$0.50 per share of profit per trade including my broker commission and fees. That is $125-$1000 profit per trade. In swing trading I hold shares for a couple days to several weeks. If I traded stocks that were priced between $5-$10 per share with a daily volume of over 1 million shares per day. This meant my trades would be $2500 to $10,000 per trade for $5 stocks and $5000-$10,000 per trade for $10 stocks.  The limitation of the amount of capital I had at my disposal and my trading rules meant that I could only purchase between 10-20 shares for a profit range of  $2.50-$10 per trade.

This is where options come in. Instead of purchasing a stock such as AMD (Advanced Micro Devices, Inc.) for $13.19 (closing price on September 1, 2017), you could buy 5-20 call options with an expiration date of January 19, 2018 and a strike price of $12 at a price of $2.34 per options.

Each options contract covers 100 shares. Therefore, instead of a capital outlay of $6595-$26,380 for the range of shares I usually trade, I only need $1170-$4680. This represents a savings of approximately 82% in capital I am risking. I only trade options that are Deep-in-the-Money with a Delta greater than 0.60 and an expiration date of at least 90 days. A Delta of 0.60 and greater means the option moves almost 100% in correlation with the underlying’s stock move.

For example, an option that has a .60 delta will move 60 cents when the underlying stock moves $1. Sometimes you can even find a deep in the money call option that has a .95 delta meaning that the option and the stock move almost 100% in tandem with each other.

The strategy I am using is called a Stock Replacement using options. Using deep in the money options I get free leverage since to margin a stock can cost you up to 7% an interest a year. An option has zero interest or borrowing costs. Please note that options by nature are volatile and requires a discipline trading strategy to mitigate loses. It took years of research and trading within paper trading accounts to hone my options trading strategy. I follow the following rules of money management below.

  • 2% Rule: I do not risk more than 2% of my account on a single trade.
  • 6% Rule: I do not risk more than 6% of my account on all open trades.
  • I use no more than a 20% stop loss on each position. Options and Stocks fluctuate. A 20% stop loss may not be triggered. This helps prevent getting whipsawed. I diligently manage my portfolio positions which allow me to eliminate weaker performing positions long before the 20% level is hit.

There are many options trading strategies; some simple and some complex. For example, one of the strategies is used to generate income using covered calls. I use something simple for capturing a few dimes of a stocks up or down trend using call and puts options. Let me know what you think. Happy Trading.



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