I tend to be more of a directional trend trader of stocks than a swing trader. I want to make a transition to using options to take advantage of risk reduction and potential leverage capabilities they can provide. But because options have an expiration date, what would be some of the best ways a trend trader could "let their winners run" or continue to participate in favorable market movement using options?
It is going to depend a great deal on your win rate and time trades are held and the size of the moves. Also on how you enter the trades (because options go to a premium on a sudden large breakout so that is a bad time to buy them). If the moves you trade are very sharp or strong and continuous, you can afford to hold a call spread or put spread or even at the money call or put for a time, but if your trades are open for a long time while the market vacillates before making its final move, long options will not work easily because of time decay.
You might want to look at Deep-in-the-money (DITM) options as a proxy. You can get a decent amount of leverage and almost completely eliminate time decay. One drawback is that usually the spread can be a bit hefty, but if you are longer term, you can work your fills a bit (if you are trading with the weekly trend, look for pullbacks on the shorter timeframes like the daily or 4-hour). That is probably the simplest way to start as spreads can be much more lucrative, but you need to be right on both the strength and the timing of the move.
That is correct...I trade a lot of these. Near month or next month is best because they have the most favorable spreads. But I stick to high-liquidity ETFs. It won't work that well with individual stocks, unless you are using about the 50 most liquid ones.
Are you still actively trading ETF with this method? Just thinking out loud, wouldn't DITM + Next Month option be relatively expensive and thus reduce your P/L?
No, not if you are using liquid options. But it might depend on the underlying. Grab some option chains and make a few assumptions, do the math. I personally think I am better off buying the shorter dated options.
Yes, to decide on getting a longer/shorter dated option, i think it really depends on what is the time frame for the underlying that we are looking at. But you have a valid point. Between, i read your earlier comment on highly liquid ETF Option is better than Stock Option when doing a pullback in trend trading... May i know why did you say so? I also did a quick check last night on ETF Option and noticed that the pickup is quite low. It will be a problem for those who want to sell ETF Option.
Spreads. deep itm options have a higher delta thus capturing more of the move dollar for dollar. Yes they are expensive so on a percentage basis your p/l will be less, but a dollar amount will be more. Plus you have a much higher chance of profiting using DITM options than OTM.
If your trading options as a directional instrument you wont be happy with the results. If you want to trade options I suggest you understand volatility and how options are priced. Usually before a breakout to new highs for example, a stocks implied vol will go up because people are betting on the same thing you are. Maybe if there is a breakout AND the option is cheap might it be a good buy.