For those unfamiliar with position trading, it’s a type of investment strategy where the goal is to hold open positions for as long as possible. It is usually done by institutional and professional traders who want to protect themselves from large movements in price. The primary issue with this strategy is that since you need to hold on to your positions sometimes for an extremely long period (months or even years), it requires patience and excellent risk management skills.
At first glance, there doesn’t seem to be much room for success using this method as frequently these days we see day traders buy and sell multiple times within a single trading day; why would anyone bother holding their positions overnight?
Having an edge
Well, first off, to gain profits from the market, you are required to have the edge over others in terms of predicting future price movements. An edge can come from various factors, including having information before the general public, having good risk management skills, or simply being extremely patient so that even if your prediction is wrong, you won’t lose much. Thus it would be naive to think everyone can profit in this competitive environment.
Reduce your holding periods
The other thing about position trading is that although it requires holding your positions for months or years, there are ways to reduce these holding periods significantly by using options strategies when you expect high volatility in prices.
In this article, let’s look at what options are, how they work and how they can be used as part of a position trading strategy.
What are the options?
They are contracts that provide the right but not the obligation to buy or sell an underlying instrument at a certain strike price before or on a specific date. In addition, it’s also an expiration date after which the contract becomes null and void if it hasn’t been exercised yet.
It can be beneficial for reducing holding periods by using options. You will no longer need to hold your positions until expiry. Instead, you can exercise your option any time before this date and still achieve almost similar results (although it may vary depending on how much of the premium has expired).
How do options work?
The best way to understand how options work is to compare them with buying insurance for your house. When you take out home insurance, you will be able to replace your house if it is destroyed by a hurricane or fire, even though this may have occurred several years ago. It doesn’t mean that the insurance company expects your house to burn down; instead, they know that hurricanes can occur any time, and they want to protect themselves from significant losses just in case a major disaster occurs.
In comparison, if you try to claim compensation after raising your hand and admitting defeat, the insurance company won’t give you anything since it wasn’t agreed upon when the contract was created.
Two reasons why you need options
About trading options for position traders, there are two reasons why one would need an option: To eliminate exposure (by either reducing risk through other positions or managing exposure using options), To achieve a higher profit (by taking advantage of options premium).
When you are trying to reduce risk, it is usually done when market volatility increases because, in such an environment, there will be more chances of your positions moving against you. To protect yourself from this possibility without exiting your positions completely, you can use a protective put strategy whereby you buy an extended position and sell a short put option which acts as insurance.
In practice, it’s not using one’s capital to purchase the insurance but rather the other party who does so because they want to bet on the price going up. Look at this site for more info.