Amplifying Gains: Using Options with Gap & Go Swing Trades

For the experienced trader, options can be a effective tool to amplify gains and manage risk in Gap & Go swing trades. This article will explore advanced options strategies that can be used in conjunction with the Gap & Go setup, providing you with the potential for outsized returns.

Entry Rules

When using options, our entry rules for the underlying stock remain the same. However, we have additional rules for selecting the right option contract:

• Option Type: We will use in-the-money (ITM) call options to maximize delta and capture the stock's movement.
• Expiration: We will select options with at least 60 days to expiration to give the trade enough time to work.
• Liquidity: We will only trade options with a tight bid-ask spread and high open interest.

Exit Rules

Our exit rules for options trades are based on the price movement of the underlying stock:

• Profit Target 1: We will sell 1/2 of our options position when the underlying stock reaches a 2R profit target.
• Profit Target 2: We will sell the remaining 1/2 of our options position when the underlying stock reaches a 4R profit target.
• Stop Loss: We will exit the entire options position if the underlying stock hits our stop-loss level.

Profit Targets

Our profit targets are based on the price movement of the underlying stock, but the percentage gains on our options position will be significantly higher due to leverage.

Stop Loss Placement

Our stop loss is placed on the underlying stock, not the option itself. This is because the option's price can be affected by factors other than the stock's price, such as changes in implied volatility.

Position Sizing

Position sizing with options is different than with stocks. We will risk no more than 0.5% of our trading capital on any single options trade.

• Position Size Formula: (Trading Capital * 0.005) / (Option Price * 100)

Risk Management

Options trading involves a unique set of risks that must be managed carefully:

• Time Decay (Theta): The value of an option decreases as it gets closer to expiration. We mitigate this risk by selecting options with at least 60 days to expiration.
• Implied Volatility (IV): A decrease in implied volatility can cause the value of our options to decrease, even if the stock price stays the same. We are aware of this risk and we may avoid trading options on stocks with excessively high IV.

Trade Management

Managing an options trade requires a close eye on both the underlying stock and the option's greeks:

• Monitor Delta: We will monitor the delta of our options to ensure that we are maintaining our desired level of exposure to the underlying stock.
• Roll the Position: If the trade is working but is approaching our option's expiration date, we may roll the position to a later expiration date.

Psychology

Trading options can be even more psychologically demanding than trading stocks:

• Leverage: The leverage provided by options can amplify both gains and losses. It is important to be aware of this and to not get carried away by greed or fear.
• Complexity: Options are complex instruments. It is important to have a thorough understanding of how they work before trading them.

By using options in a disciplined and responsible manner, you can amplify your gains and add a new level of sophistication to your Gap & Go swing trading.