The small-cap benchmark Russell 2000 is a swing trader's dream. Here we will explain how to trade using options. Although it is very volatile and exhibits wild ups and downs, the one-year daily chart shown below clearly shows how its movements are confined to well-defined trading ranges. Indices frequently fluctuate between established support and resistance levels. Breaking out of one of these levels will quickly stabilize in a new trading range. Currently, the index range is between 2260 and 2100. It recently encountered resistance at 2260 on September 19th and has started a pullback since then. Based on this analysis, I am considering a bearish setup keeping in mind the upper end of the current trading range. Trading Given the bearish outlook, I am using a call credit spread as my trading structure. This setup involves selling a $2,260 call option strategically placed at the current resistance level. To limit the potential upside risk and define the maximum loss of the trade, we simultaneously purchase a $2,270 call option. A review of the Russell options chain shows a 70% chance that the price will stay below $2,260 at expiration, indicating that this setup has a high chance of success. This trade has a potential premium profit of $300, and the loss limit is $700. If the index falls below $2,260 by expiration, the trade will yield a 42% ROI on the capital at risk. My exact trading settings are: Sell a $2260 call, expiring on October 11th Buy a $2270 call, expiring on October 11th Credit: $300 A credit spread like the one outlined here provides a good probability of success; Approximately 7 out of 10 deals are expected to be successful. Finish with a profit. However, there are important considerations. Successful trades usually result in small profits that accumulate over time, while losses from unsuccessful trades can be more substantial. In some cases, the losses from just three losing trades can offset the profits from seven winning trades. This highlights the need for a strong risk management strategy. By setting a predetermined stop loss level and adhering to it, you can minimize the impact of trading losses and prevent large drawdowns. With consistent discipline, credit spreads have the potential to generate stable returns over the long term while effectively managing downside risk. -Nishant Pant Founder: https://tradingextremes.com Author: Mean Reversal Trading with Options and Technical Analysis Youtube, Twitter: @TheMeanTrader Disclosure: (None) All opinions expressed by CNBC Pro contributors are , are solely their opinions and do not reflect their opinions. Opinions are those of CNBC, NBC UNIVERSAL, its parent or affiliate companies and may have been previously disseminated on television, radio, the Internet, or other media. The above is subject to our Terms of Use and Privacy Policy. This content is provided for informational purposes only and does not constitute financial, investment, tax, or legal advice or a recommendation to purchase any securities or other financial assets. The content is general in nature and does not reflect your unique personal circumstances. The above may not be appropriate for your particular situation. Before making any financial decisions, you should strongly consider seeking the advice of your own financial or investment advisor. Click here for full disclaimer.
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