I thought it would be cool to show you a typical options set-up and the dilemma that you run into when making a decision to tolerate a pullback or not. I’m a big believer in swing trading with options, I’m not one to hold an option through to much pulling back. I believe time and risk is money and when price thrusts especially after a couple of gaps I’m out. Take a look at the following image. I’ve pointed out where one might have considered buying some puts. Nice resistance level, price is still in a consolidation period so mo break-out is expected, and no new pay-cycle is expected to start just yet, so a short move down is anticipated.
The question becomes long dated or short dated options (60 days or 6 months) the easy answer here is 60 days because we don’t expect this to be some gigantic move. Also I’m not one to miss out on the short term explosive move just to be holding a long dated option, so 60 days would be about my max. here.
So notice the top two arrows, those are potential entry points because of completed swings at strong resistance. So either one provides 1.) Low risk and 2.) reasonably high odds. Lets look at entry at that point and an exit at the first arrow with a short term option 3 legs out of the money with 67 days to expiration.
So the following example is ENTRY at the second top arrow and exit at the first (quicker exit) bottom arrow with 67 days to expiration 3 legs out of the money puts.
8/9/10 – BUY Oct. $110 (67) days to expire – $3.21 | 8/12 Three days later sell for $5.41 = 68.5% return – If we held until we reached the bottom arrow (longer exit) we would sell it for $6.62 for a profit of 106%.
Now lets look at the same entry (second arrow top) and a longer dated option.
8/9/11 BUY March 2011 $110 (221) days to expiration – $7.69 Three days later sell for $10.08 = 31% = If we held until we reached the bottom arrow (longer exit) we would sell it for $11.46 for a profit of 49%
68.5% / 106% (67 days to expire)
31% / 49% (221 days to expire0
There are a few other things to consider like implied volatility, but I wanted to give you a real life example of the lack of exposure to short term moves with much longer dated options. You should also be aware that the lack of time exposes you to serious theta (time) decay and this is why the balance of right around 60,70 and 90 days is just about perfect for an option position you plan on holding for 1 to 5 weeks.
Hope this helps !