Using options to trade an index that’s become a swing trader’s dream

The small-cap benchmark Russell 2000 is a swing trader’s dream. Here’s how to trade it with options. Although it is very volatile and exhibits wild swings, in the 1-year daily chart shown below, it becomes evident how confined its movement is within a well-defined trading range. The index frequently fluctuates between established support and resistance levels. Whenever it breaches one of these levels, it quickly stabilizes in a new trading range. Currently, the index’s range lies between 2260 and 2100. Recently, on 9/19, it encountered resistance at 2260 and has since started a pullback. Based on this analysis, I am considering a bearish set-up while keeping the top of its current trading range in mind. The trade Given the bearish outlook, I’m using a call credit spread as my trade structure. The set-up involves selling a $2,260 call option, strategically placed at the current resistance level. To limit potential risk on the upside and define the trade’s maximum loss, I’m simultaneously purchasing a $2,270 call option. A review of the Russell options chain indicates that there is a 70% probability of the price remaining below $2,260 at expiration, providing a strong probability of success for this set-up. This trade offers a potential premium gain of $300, with a possible loss capped at $700. If the index stays below $2,260 by the expiration date, the trade will yield an ROI of 42% on the capital risked. Here is my exact trade setup: Sell $2260 call, Oct 11th expiry Buy $2270 call, Oct 11th expiry Credit: $300 Credit spreads, like the one outlined here, provide a favorable probability of success, with expectations that around 7 out of 10 trades will end profitably. However, there’s an important consideration: while winning trades typically offer modest gains that can accumulate over time, losses from unsuccessful trades can be more substantial. In some cases, the losses from just 3 losing trades could potentially offset the profits made from the 7 winning trades. This underscores the need for a strong risk management strategy. By setting predetermined stop-loss levels and adhering to them, you can minimize the impact of losing trades and prevent significant drawdowns. With consistent discipline, credit spreads have the potential to generate steady returns over time while managing downside risk effectively. -Nishant Pant Founder: Author: Mean Reversion Trading using Options and Technical Analysis Youtube, Twitter: @TheMeanTrader DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.