CHAPTER 7
OPTIONS FOR
SHORT-TERM PROFITS
‘Civilization and profits go hand in hand.’
—Calvin Coolidge, November 27, 1920
T
he typical distinction between long-term investing and
outright speculation is quite broad, often with little room
in between. The tendency is to group people into those
favoring one extreme or the other. Long-term investors,
also called value investors, tend to be quite conservative
and risk-adverse. On the other hand, speculators tend to
be reckless and willing to put their capital at risk in pursuit
of exceptional profits.
There is room for a balance in most portfolios. For ex-
ample, you already know that it is possible to use options
to speculate on short-term price aberrations, or even to
write short spreads and straddles as part of a low-risk con-
tingent purchase plan. These strategies are usually classi-
fied as very high-risk. Even so, as Chapter 6 demonstrated,
the risk has to be qualified. For example, as long as the
short call side of a combination is a covered call, the only
153
154 Winning with Options
question remaining is whether you are willing to risk hav-
ing a short put exercised. Given the high return possible
from a well-designed contingent strategy, it is clear that
even the most conservative risk profile can benefit from
option strategies, and this is true in many forms.
There is more to this distinction. It is also possible for
you to continue maintaining a highly conservative portfolio
and still benefit from short-term price movement. As long
as you do not compromise your risk tolerance levels or
place capital at risk that you cannot afford to lose, you can
devise many strategies aimed at creating short-term profit
potential apart from your permanent portfolio. This in-
volves a series of timing trades commonly called a day
trading strategy.
This term refers not only to the extremely short-term
nature of the trades in and out of positions but also to the
common practice of opening and closing positions within
a single day. Historically, day traders have used stocks as
well as options, opening and closing trades in high volume,
and often leveraging tremendous profits (and losses) with
little capital at risk.
This is where problems have arisen. The margin re-
quirements imposed on trading accounts are well known,
but they apply to end-of-day balances. For example, if you
buy stock on margin, you are required to have at least 50
percent of the current value kept in your account. How-
ever, if you move in and out of stock or option positions
and close them out by the end of the day, you escape the
margin requirement altogether. For this reason, the Secu-
rities and Exchange Commission (SEC) devised the pat-
tern day trading rule (see Chapter 4). This rule states that
if you make four or more trades within five consecutive
trading days, you are classified as a pattern day trader. You
are then required to keep at least $25,000 in your account.
If you do not maintain this minimum balance, you are
155Options for Short-Term Profits
banned from any further trades in the stock or its options
until you meet the cash requirement.
This rule shut down many of the more abusive day
trading practices. Today, only those traders who maintain
a high enough balance are allowed to transact high-volume
trades. However, the rule also created a new type of short-
term strategy, known as swing trading. This is defined as
a series of trades opened and closed within three to five
consecutive trading days (there may be more days in-
volved, but the three- to five-day time frame is most
common).
This chapter shows how swing trading can be a good
fit even for the most conservative portfolio, and how you
can use options as part of a swing trading strategy. Op-
tions allow you to diversify your swing trading exposure
with high leverage and for relatively low risk. Compared to
swing trading using shares of stock, using options pro-
vides you with greater flexibility and helps you to avoid the
big problem with swing trading: the need to go short on
half of all trades. With options, you can play the short side
of a trade using long puts instead of shorting stock. This
makes options ideal for swing trading, and as long as you
make a distinction between your long-term portfolio goals
and the short-term swing trading activity, you can employ
both without violating your risk tolerance level.
The Contrarian Approach
When you pick stocks, you probably use several funda-
mental indicators to narrow down your list. These may in-
clude dividend rate, revenue and earnings, debt ratio,
current ratio, P/E ratio, and other value-based tests. If you
are a value investor, you then seek companies whose stock
is available at a bargain price.

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