Ever since I posted my last article, I’ve been getting a ton of emails asking me how to apply my trading techniques to the options market…
So in this article, I’m going to give you the best swing trading options strategy for beginners I know.
I didn’t want to talk about options much at first because I wanted us to focus on swing and day trading stocks, futures and currencies.
I always tell my students to stay away from swing trading options strategies until they have a good handle on making money with actual assets before moving on to trading derivatives.
But if you’ve been keeping up with these articles, then you should be ready for the best swing trading options strategy for beginners.
My Take on the Best Swing Trading Options Strategy for Beginners
When I started trading back in the early ’90s, I traded stocks, commodities, futures, options and forex.
By the time I started trading options, I already knew enough about the markets and, more importantly, about risk and making good decisions.
But looking back, if I started trading options instead of other markets, I wouldn’t have developed the necessary foundation and discipline to succeed.
Volatility Is the Key to Success
One of the biggest reasons why people run into trouble when they first start swing trading options is because they lack the basic understanding of implied volatility and how it can impact and distort prices.
I mean, did you know that options can increase and decrease in value based on simple perception and nothing more?
Did you know that during the stock market crash of 1987, or Black Monday, both the calls and puts increased in value several times over simply because of fear?
So with the best swing trading options strategy for beginners, the most important factor isn’t market direction…
But rather the future perception of price — or implied volatility — which shows the market’s opinion of the stock’s potential moves or the expectation for the future.
I could spend hours explaining the technical definition of implied volatility and options pricing. I used to be obsessed with the Black-Scholes model and probability calculations.
But I’ll just share a short story with you…
It’s had a major impact on my swing trading strategies and how I constructed them after this unfortunate event occurred.
My Personal Options Trading Story
I remember the first time I read “Options as a Strategic Investment.”
It’s like a bible for options trading.
It’s over 800 pages but as I read, I realized the more I learned about implied volatility, the more profitable I would be.
I remember learning that if you sell options that have high volatility, in the long run, you’d make money.
That’s because statistically, options will go to fair value. So over time, you’ll make money by selling expensive options and buying them back when volatility is low.
This made sense to me because I naturally think in terms of probability. And this was nothing more than getting something expensive and getting rid of it when it’s cheap.
I got excited and rushed out to get the next morning’s Investor’s Business Daily at the newsstand…
There wasn’t internet at the time and the next day’s paper came out at 8 p.m. EST the night before.
I remember the newspaper had an options table that made it easy to get all the options prices that were traded that day. This would give me at least some idea of what to look for and what’s cheap or expensive volatility-wise.
I ended up picking about five tech stocks.
The volatility on them was high. I mean, these suckers were priced two to three times what other options cost with similar risk and strike prices.
I thought I was getting lucky here. So the next morning, I ended up selling about $5,000 worth of premium that had about three weeks to go before expiration.
I Thought I Discovered the Options Trading Holy Grail
I thought I did well and couldn’t believe my luck…
I thought I found the pot of gold at the end of the rainbow, for lack of a better phrase.
But naturally — and anyone who’s ever sold an option premium will tell you this — time begins to move slow when you’re selling options.
Within the next four to five days, each and every one of the options I sold skyrocketed.
One stock got bought out, another posted incredible earnings, and the others just took off.
This is when I figured out something important, and I want you to understand it without losing your shirt…
When options are overly expensive, there’s typically a strong underlying reason for it.
Just like when you go to the racetrack and the best horses pay out 2-to-1 while others that are less likely to win have odds of 10-to-1 or 20-to-1. There’s a reason for this and typically it’s right on the money.
I’m telling you this story because I don’t want you to get too caught up in the options Greeks because they never helped me make one penny when trading options.
All those software programs that tell you which option is expensive or which is cheap are great… but the problem is they don’t tell you why they’re priced that way…
And if the option has a pulse or any type of volume to it, it will typically be priced high or low because of an underlying reason.
This is something the Greeks will never tell you, and it has much more impact on the options price than any mathematical or statistical calculation ever will.
The Best Swing Trading Options Strategy for Beginners That Works
Now that you know a little about how options are priced, I want to share the best swing trading options strategy for beginners so you can apply it to your trading right away.
This strategy takes implied volatility into account, so you will buy both calls and puts when they’re cheap, or when implied volatility is on your side.
As most of you know, I’m not a counter-trend trader…
I always follow the trend and try not to pick market tops or bottoms.
But when you’re trading options, investing in the direction of the trend means buying options at expensive prices and offsetting them when they’re more expensive.
One way to combat implied volatility is to use a counter-trend method.
I typically don’t use counter-trend methods with assets… But in this case, we’re not trading assets. We’re trading derivatives of those assets, so we have to do it differently.
One of my favorite methods to time my purchases is to use market exhaustion patterns.
It’s similar to the Tail Gap Pattern.
We want to look for exhaustion, or if there’s no gap, at least a bar with a lot of range opening in one direction and closing in another.
You’ll usually find this about two to three times per year on most large-cap stocks that aren’t trending strongly.
Buy Puts When Premium Is Low
Take a look at the example below of Valero Energy Corp. (NYSE: VLO).
VLO goes through a reversal when most traders expected further upside movement. This is when volatility to the upside is high.
If you were to buy a call option at this price level, I doubt you’d make money even if the stock goes up about 4 to 5 points.
The stock would have to move up strongly for call options to keep gaining, unless the momentum would slow down and the volatility would decrease.
A smart trader would buy put options when the stock begins breaking down.
The put options would have so little volatility that even if the market went against you for a day or two, the option’s volatility would be so low that the price would most likely not fall too much.
Buying Calls When Premium Is Cheap
In this example, we have a near-perfect example of an exhaustion pattern to the downside.
The put options were overpriced so much that if you were to buy a put the day before the big drop, you would barely see any increase in price.
But if you bought a call option around the time the market bottomed, and even if you were off by a few points, the volatility would be so low that it would barely go against you.
Keep Swing Trading Options Strategies Simple
I hope you found this article about the best swing trading options strategy for beginners helpful.
Always remember that implied volatility isn’t something you can ignore, and it can take on a life of its own to distort the true value of your options contract.
So it’s possible for the market to go up and your options down in value because the market’s perception of the future isn’t as optimistic as it was two days earlier!
Wishing you the best,
Roger Scott
Senior Strategist, WealthPress
