Utilizing Index Options for Profit

If you are accustomed to trading futures or binary options, or stocks on various equities markets, you may consider exploring options on various markets.  An option is a derivative contract with similar leverage to that of a futures contract.  The benefit of an options contract is a limited risk characteristic.  You gain the benefit of trading a chart setup without having a stop loss.  But on the contrary you do have a time limit on your trade.

Many markets, many expirations:

You can utilize options to trade virtually anything, there are options on futures markets and options on equities … and everything in between.  I like to trade index options on the S&P since they are very liquid and they have weekly expirations.  The CBOE carries cash index options that have great liquidity compared to ETF options.  In the old days you had monthly expirations which limited you to buying or selling a lot of time value.  Today with the shorter expiration times of weekly expirations you have the ability to capture shorter term swing moves over a couple of days with a weekly option and very little time value.  These shorter term contracts can move very fast if you get a good move in the underlying market.  A typical weekly contract can move at a rate of 2:1, 3:1 and 4:1 in typical trading scenarios throughout the week.

Higher time frame setups:

I like to trade the higher time frame chart setups because it gives me a greater margin for error ... because with an option I am always looking for a sustained move in the underlying price action.  The higher time frames do that for me.  A setup on the weekly or daily chart can produce dramatic results over just a few days and many times over several weeks.  If however, it happens to be expiration Friday, then I am able to trade a contract with little to no time value and that translates to smaller market moves to accomplish the same results … so in that case I just move down to the lower time frame charts like the 30, 15 and 5 minute time frames to get my setups.  When speaking of setups, I am referring to a specific trade strategy that I am looking for in the price action.  This is really the key to trading any instrument whether it is an option, a future, or a stock for that matter – you still need to predict the market direction accurately. So I would still use the strategies we teach here at Trade with Precision for timing entires and predicting market direction however I would express that trade using options. 

Different trading opportunities:

With an option, you also have the ability to trade economic news events by creating a non-directional, straddle type of trade with a short-term contract.  So the shorter term expirations can really add another element to your game and potentially bring you off the sidelines to recognize different trading opportunities.  I personally prefer trend trading; I just think it has a higher probability setup.  Many times I am looking for a good trending setup on the 8 hour, 4 hour, and 2 hour time frames.  This provides me with good trading opportunities when there is no setup on the weekly or daily charts.  By understanding the time frame that my trade sets up on, I know it will be a shorter hold period than say a daily or a weekly setup.

Overall, the structure of options contracts creates new and different opportunities for me to trade the same markets.  The structure of an options contract changes my reward to risk to sometimes being more favorable than a futures contract.  And with the greater assortment of expiration times, I am presented with more opportunity.  As with any options contract, you know your maximum risk on the trade in advance – and you are not getting stopped out all the time.  The contracts can go to zero, and they do often … but you are not getting stopped out on a price spike.

By Toby Genaro

Regards,
The TWP Team
www.tradewithprecision.com