Options

What’s the Choice?

Simple definition – options are simple financial derivatives. This contract gives you the right to buy or sell an asset at or within a predetermined date (exercise date). If you are a seller you have an obligation to fulfill the terms of the transaction. This will either be to sell or buy if the buyer chooses to ‘execute’ the option before the expiry date.

Options for day trading cover a wide range of markets. You can get stock options, ETF options, futures options and more. This traditional option is also known as the ‘vanilla option’.

What is an Option Contract?

You will be given several rights with an option contract. Each contract must include the following details:

• Type of option (call option or option)
• Basic security
• Strike price (the price at which you can exercise the option)
• Trading unit (number of shares)
• Expiry date (last trading day to exercise your option)

Type

Options are often classified as a complicated, risky investment, and give rise to many ambitious day traders. However, there are only two main class options.

• Put – This put option allows you to sell the stock at a certain price.
• Call – This purchase option allows you to buy a stock at a certain price.

Leaving aside the two main classes, there is a long list of different markets and options. While not all are suitable for day trading, the list includes:

• Stock options
• Index Options
• Mini options
• Mini Index Option
• Options in the future
• Weekly SPY Options
• OEX option
• ETF options
• S&P 500 Options
• IRA account
• E-Mini option
• ES weekly selection
• QQQ options
• Deep in-currency (ITM) options
• Crude oil options

Underlying Assets

Typically, you’ll find that most options are based on shares in publicly listed companies, Twitter and Amazon, for example. However, there are many options based on alternative investments. These include day trading options on stock indexes, currencies, commodities, and real estate investment trusts (REITs).

Stock Options

If you are interested in day trading stock options for life, it is important to know that the contract is based on 100 shares of the underlying stock. The exception to this rule is when adjustments occur as a result of stock splits and mergers.

Regional Differences

The majority of exchange-traded stock options are American. They can be exercised at any time from the date of purchase to expiration. European options, however, you can only redeem on the expiration date.

Options vs Futures

Many people quickly realize that there are many similarities between day trading options and futures. Both are usually based on the same underlying instrument. Actual contract speech also shares many similarities.

The difference is how they are traded. With options, you will get various options available. You will also find different trading rules. Options can be traded alone, or you can buy them in conjunction with stock trades or futures contracts to create a form of insurance in the trade.

Why Trade Options?

There are several reasons you can make serious money trading choices. Even putting the financial rewards aside, day trading with options appeals for a number of interesting reasons.

• Low cost strategy – Day trading in options gives you the opportunity to enter and exit positions faster and with less risk than other securities, such as stocks and mutual funds. It is also much cheaper to buy options than to buy the underlying asset, shares of stock, for example. Therefore, you can control the same number of shares with much lower capital.
• Diversification – Because options are cheaper than buying actual stocks, you can benefit from increased investment opportunities. Your capital will continue to grow, increasing your profit potential.
• Greater profits – When stocks move you can profit more with options. Let’s say the stock moves from $25 to $50. That will bring you 100% profit in the stock. However, a call option moving from $1 per contract to a $5 contract will bring you a profit of 500%. Therefore, you can get more profit and less time with options.
• Options can succeed where other sectors fail – Even when some market sectors fail, options can succeed. This is partly because you don’t have to exercise your options to profit from them. Furthermore, volatility itself can be profitable.
• Mutually beneficial – Although options are often built on stocks, combining the two and they can bring you greater benefits. This is because you can sell your options to generate income on the stocks you own.

Day trading options trading is varied and brings huge profit potential. The best part though – the accessibility. You can start day trading with options from anywhere in the world. All you need is an internet connection.

Weakness

While there are many benefits, there are some challenges that come with trading in options. Fortunately, all of the obstacles listed below can be overcome.

• Bid-ask spread – Compared to stocks, the bid-ask spread is often wider. This is a result of the reduced liquidity available in the options market. This can fluctuate by as much as half a point, which can reduce day trading profits.
• Reduced price movement – ​​You may find that price movement is limited by the premium time value element of your choice. Although the value increases with the price of the underlying instrument, the profit can be underestimated to the extent of the loss of time value. Fortunately, the time value for option day trading is quite limited.

These two disadvantages should not stop you from day trading options in search of income. If you consider both considerations, you can adjust your trading plan accordingly.

How to Start Trading Options

Day trading options for beginners requires a few simple steps.

Open a Brokerage Account

Your broker will help facilitate your trade. Today there are many online brokers to choose from. The challenge is finding someone who meets your individual needs. You need to consider several factors when making your choice.

• Cost – Compare commissions between different brokers. You will also find some brokerages that offer zero commission fees for trading options. Also, check their payment structure is simple and there are no hidden costs. You should make sure you get a competitive spread.
• Account type – Do you want to start day trading options in a cash account, or do you want a margin account? With a cash account, you can only trade capital that you actually have. However, a margin account will allow you to borrow money from your broker to leverage trades. A margin call option will give you increased buying power. Keep in mind cash accounts will only allow you to buy options to open positions. You need a margin account to sell options without owning the underlying asset.
• Platform – This is where you will spend a large amount of time. The best platform for trading options will offer all the charts and technical tools you need to trade effectively. If you trade on the go, you may also want to investigate their mobile and tablet apps.

For more guidance on making the right decision, see our list of brokers.

 

Strategy

Once you are set up with a broker and you have your own trading room ready to go, you need to use an effective strategy. Strategies for day trading options come in all shapes and sizes, some simple and some complicated. Before we look at examples, there are a few important components that most strategies require.

Charts & Patterns

Unless you are trading using the news, you will probably use charts and patterns to predict future price movements. They work on a simple hypothesis, that history repeats itself, and you will find many wealthy traders who wholeheartedly agree with that statement.

Your charts will need the best indicators for trading options. This varies from strategy to strategy, but it includes:

• Enter the Call Ratio Indicator
• Money Flow Index
• Open Interest
• Relative Strength Index
• Bollinger Bands

You will find that trading patterns with options requires hard work and practice. You need to tighten up any creases and try a few different charts until you can see one that paints a clear picture with the numbers.

Time

Timing is everything. Not only when you enter and exit trades, but also when you set for the trading day ahead. Options strategies that work usually have traders behind them bright and early.

For example, you might want to be as early as 06:00 ET if you want to get a feel for the markets heading into Europe and into the US. You can start setting your trading strategy based on what your market has done overnight.

Take E-mini for example, up to 70% of stocks will move in the same direction as E-mini. If you know this, you can also tell if most stocks will be up or down when US markets open at 9:30am ET.

Keep in mind that the US often sets the direction of world markets. Therefore, it makes sense to wait an hour for the market to settle a bit before entering your first trade.

Day trading on options requires careful analysis and significant time. Make sure you are ready to put in the hours if you want to make big profits.

Example

This is one of the basic options strategy that works. If the market is rising, you will buy a call or a put. If the market is going down, you will sell the call or buy it. Many choose to sell options rather than buy them. However, some equities move so well that buying an option can produce a bigger profit than selling an option and waiting for it to go downhill. Apple is one such example.

Let’s go back to the E-mini. You will be patient in the first hour and then you will look to see where the E-mini is trading based on its opening, and whether Apple is trading in the same direction based on its opening.

If so, you would buy at-the-money, or call the first exit call if heading higher, or put if heading lower. Now you sit and wait for half an hour to see if you trade in the right direction. If so, you will stop at half the value of the option you bought. So if you buy it at $10.00, you would place a stop at $5.00.

If the market moves then exit. There are more opportunities out there. However, if the trade looks promising then you will wait a few hours and reassess at 2:00pm ET. If the market continues in your direction, you can stay with it and place your stop on the other side of the open around 8-12 cents.

If it continues to look promising, you can reassess around 3:30pm ET before the market closes. You can then make a final decision and hopefully calculate your profit.

For more guidance, see our strategy page.

 

 

Tips For Trading Options

Even with good options day trading techniques, you can benefit from invaluable tips. From risk management and preferred stock options to education and regulations around taxes, below you’ll find top tips that can keep you firmly in the black.

Education

One of the top tips is to immerse yourself in the educational resources around you. The best traders are constantly digesting information. You don’t want to be left behind because of market changes. Jeff Augen’s trading options is available for free download and is considered one of the most useful resources out there. However, you should also consider the following:

• Books & Ebooks
• Course
• Chat room
• Video tutorial
• PDF (eg Tom Demark day trading example pdf)
• Forum
• Blogs
• Podcasts

Demo Account

It’s hard to resist the urge to throw your hat in the ring early on. However, getting to grips with stock options strategies with a demo account for the first time is often a wise decision. Not only can you reduce the weaknesses in your trading plan, but you can also try out your broker’s platform before you buy.

They are funded with simulated money so you don’t have to worry about risking the capital earned. A Demo Account is an ideal place for trial and error.

 

 

Rules & Restrictions

It is important that you know the rules for day trading options in your country and market. For example, in the US, there are FINRA trading regulations on options. This rule stipulates that if you meet the criteria of a ‘pattern day trader’ (trade more than four times in five working days), you must hold an account with at least $25,000. Therefore, if you do not have significant capital to start with, then the trade may not be off, right now.

However, while pattern day trading does not apply to options in the US, many other countries do not have such restrictions.

Tax

In other countries, you may have to consider taxes. How are your profits taxed? Will they be considered personal income, business income, speculative or non-speculative? Your tax obligations can affect your bottom line. So, know what kind of tax you have to pay and how much?

Software

One of the best day trading options tips if you have an effective strategy is to consider using automated software. Once you have programmed in your criteria, the algorithm will execute the trades on your behalf. This can speed up trading time, and it allows you to make more trades than you could manually. However, it is important to note that this is the most effective tool when you have a consistent strategy in place.

risk management

Whether you day trade using weekly options, or you trade daily AAPL options, a risk management strategy is essential. This will help you minimize your losses and ensure you always get another crack at the market.

Many experienced traders advise using the 1% rule. This rule states that you cannot risk more than 1% of your account balance in a single trade. Therefore, if you have $40,000 in your account, the maximum position size you take is $400. Once your strategy turns consistent results then you can consider increasing your risk between 2-5%.

Take Points Away

As a day trader, you have two objectives. First, make money. Second, do so with minimal risk. Options are the ideal instrument for day traders looking for both. When day trading options are good, you have the ability to set clear limits on risk, and the ability to buy and sell options multiple times to profit again from stock price movements. They offer advantages that other financial instruments do not necessarily.

In addition, whether you day trade S&P 500 options, or delta options and spies, there are always interesting options. As the popularity for traditional options grows though, it’s important that you use all the resources around you to assert a competitive advantage. This means diving into books and online tools, and honing your strategy.

Finally, as Robert Arnott said, ”  In investing, what is comfortable is rarely profitable  .” So enjoy the road ahead, it may be bumpy, but it could also be filled with gold.