Trading options was not part of most traditional intraday strategies. However, times are changing, and today some investors make considerable money using options. This guide will highlight the benefits and drawbacks of trading on options, as well as the different types of products, how to get set up, and top tips. We have also compiled a list of the best options trading brokers in 2022.
The straightforward definition – an option is a financial derivative. This legal contract allows you to buy or sell an asset during or within a pre-determined date (exercise date). If you are the seller, you must meet the transaction’s terms. These will be to either sell or buy if the buyer chooses to ‘exercise’ the option before the expiration date.
Options for trading span across numerous markets. You can get stock options, ETF options, futures options, and more. These traditional contracts are also known as ‘vanilla options’.
What Is An Option Contract?
An investor is afforded several rights with an options contract. Each contract should include details of the following:
- Underlying security
- Type of option (call or put option)
- Unit of trade (the number of shares)
- Strike price (the price at which you can exercise the option)
- Expiration date (the last trading day to exercise your option)
Options are often classified as complicated, risky investments, putting off many aspiring day traders. However, there are two primary classes:
- Put – Selling options allow you to sell a security at a specific price
- Call– Buying options allow you to purchase a security at a specific price
Setting aside the two main classes, a long list of different options products across various markets are available. Although not all are suitable for day trading, the list includes:
- Timer calls
- S&P 500
- Crude oil
- ES weekly
- SPY weekly
- Mini Index
- Interest rate
- IRA accounts
- Forward start
- Variance swaps
- Options on futures
- Contingent Convertible Bonds (CoCos)
- And even day trading ITM options (deep in the money)
Turbo warrants are also popular in Europe and Hong Kong. Turbos are essentially leveraged contracts used to speculate on low-volatility assets with built-in knock-out levels that pay out as soon as a specified price level is hit. Retail investors typically use them to go long and short or hedge against other positions.
The Underlying Asset
Most options are based upon shares in publicly listed companies, for example, Twitter and Amazon. However, there is a growing number based on alternative underlying investments. These include day trading options on stock indexes, currencies, commodities, and real estate investment trusts (REITs).
If you’re interested in day trading stock options for a living, it is worth knowing that contracts are typically based on 100 shares of the underlying stock. The exception to this rule is when adjustments occur due to stock splits and mergers.
The majority of exchange-traded stock options are American. They can be exercised at any point from the purchase date to expiration. European options, however, you can only redeem on the date of expiration.
Options vs Futures
There are several similarities between day trading options and futures. They are both usually based on the same underlying instrument. The makeup of the actual contracts also shares numerous similarities.
The difference is how they are traded. With options, you get a broader range of contracts. The trading rules also differ. Options can be traded singularly, or you can purchase them alongside stock trades or futures contracts to create a form of insurance on the trade.
Why Trade Options?
There are several reasons why you can make serious money trading options. Even putting financial remuneration aside, day trading with options appeals for several reasons:
- Low-cost strategy– Day trading in options allows you to enter and exit positions quickly and with less risk than other securities, such as stocks and mutual funds. It is also cheaper to purchase an option than to buy the underlying asset, such as shares in a stock. This means you can control the same number of shares with less capital.
- Diversity– Because products are cheaper than buying the actual stock, you benefit from more investment opportunities. Your capital will go further, increasing your profit potential.
- Greater benefits– When the stock moves, you can gain more with an option. Let’s say a stock moves from $25 to $50. That would bring you a 100% gain in shares. However, a call option move from $1 per contract to a $5 contract would bring you a 500% gain.
- Success where other sectors fail– While some market sectors fail, options can succeed. This is partly because you do not need to exercise your option to profit from it. Plus, volatility itself can be profitable.
- Mutually beneficial– Although options are often built on stocks, combine both and they can bring you greater benefits. This is because you can sell your option to create income on the stocks you already own.
Intraday options trading is multi-faceted and brings with it profit potential. The best part, though – is accessibility. You can start day trading from anywhere in the world. All you need is an internet connection and a top-rated broker.
Despite the numerous benefits, particular challenges come with trading in options:
- Wide bid-ask spreads– Compared to stocks, bid-ask spreads are often wider. This is a result of the reduced liquidity found in options markets. This can fluctuate as much as half a point, which can reduce the profit of a day trade.
- Price movement reductions– You may find price movement is limited by the time value element of your options premium. Despite the value increasing with the underlying instrument’s price, the gain can be undermined to an extent by the loss of time value. Fortunately, the time value for options day trading is relatively restricted.
Both of these drawbacks shouldn’t prevent you day trading options in the search for income. If you take both considerations into account, you can adjust your investment plan accordingly.
How To Start Trading
Day trading options for beginners require following a few straightforward steps:
Open A Brokerage Account
A broker will help facilitate your traders. Today there are numerous online brokers to choose from. The challenge is finding one that meets your individual needs. Consider several factors when making your choice:
- Costs– Compare the commissions between different brokers. Some brokerages offer zero commission fees for trading options. Also, check the fee structure is straightforward and has no hidden costs.
- Account type– Do you want to start day trading in a cash account or a margin account? With a cash account, you can only trade the capital you have. However, a margin account will allow you to borrow money from your broker. Margin call options will give you increased buying power. It’s worth noting a cash account will only allow you to purchase an option to open a position. You will need a margin account to sell an option without owning the underlying asset.
- Platform– This is where you will spend a lot of time. The best platform will offer all the charts and technical tools you need to invest effectively. If you trade while on the move, you may also want to investigate their mobile and tablet apps. Note, for an advanced options trading platform, check out TradeHawk.
For more guidance on making the right decision, see our brokers list.
Once you’re set up with a broker and have your own investing room ready to go, you will need to employ an effective strategy. Strategies for day trading options come in all shapes and sizes, some straightforward and some complicated. Before we look at an example, most strategies will need a couple of essential components:
Charts & Patterns
Unless you’re investing using the news, you will probably utilize charts and patterns to predict future price movements. They work on a simple hypothesis that history repeats itself, and you can find many rich traders who agree wholeheartedly with that statement.
Your chart will require the best indicators for trading options. These vary from strategy to strategy, but they can include:
- Put Call Ratio Indicator
- Relative Strength Index
- Money Flow Index
- Bollinger Bands
- Open Interest
Importantly, pattern trading with options takes hard work and practice. You will need to iron out any creases and try several different charts until you find one that paints a clear picture with numbers.
Timing is everything. Not just when you enter and exit the trade, but also when you set up for the day ahead. Options strategies that work usually have an investor behind them who is up bright and early.
For example, you may want to be up as early as 06:00 am ET to get a feel for the direction of the markets heading through Europe and coming into the US open. You can start setting up your trading strategy based on what your market has done throughout the night.
Take the E-mini, for example. Up to 70% of stocks will move in the same direction as the E-mini. Knowing this lets you know if most stocks will go up or down when the US market opens at 9:30 am ET.
It is worth bearing in mind that the US often dictates the direction of the world markets. So, you may want to wait an hour for the market to settle somewhat before entering your first position.
Note, day trading on options requires careful analysis and time. Make sure you’re willing to put in the hours if you want to generate profits.
This is one of the basic strategies that can work. You buy calls or sell puts if the market is on the rise. If the market is on the decline, you sell calls or buy puts. Many prefer to sell options than buy them. However, some equities move so well that purchasing the option can yield greater profits than selling the option and waiting for it to go downhill. Apple is a popular example.
Let’s go back to the E-mini. You could be patient in that first hour, and then see where the E-mini is trading based on its open and whether Apple is trading in the same direction based on its open.
If it is, you could buy an at-the-money or first strike out-of-the-money call if heading higher or put if heading lower. Now you sit back and wait for half an hour to see if you invested in the right direction. If so, you could place a stop at half the value of the option you bought. So, if you bought it at $10.00, you could place the stop at $5.00.
If the market turns, then get out. There are plenty more opportunities out there. However, if the trade looks promising, you might want to wait a few hours and re-evaluate at 2:00 pm ET. If the market continues in your direction, you could stay with it and place your stop on the other side of the open by around 8-12 cents.
If it continues to look promising, you can re-evaluate at around 3:30 pm ET before the market closes. You can then make a final decision and hopefully count your profits.
For more guidance, see our strategies page.
Tips For Trading Options
You can always benefit from invaluable tips, even with nifty options day trading techniques. From risk management and stock options tips to education and rules around tax, below you will find top tips that could keep you finish in the black.
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 as the market changes. The Jeff Augen day trading options PDF is available for a free download, for example. It is considered one of the most useful resources out there. However, you may also want to consider the following:
- Chat rooms
- Books & Ebooks
- PDFs (e.g., Tom Demark day trading options pdf)
- Video tutorials (e.g. options trading day in the life videos)
It can be challenging to resist the urge to start investing money early on. However, getting to grips with stock options strategies with a demo account first is often a wise decision. Not only can you iron out any weaknesses in your trading plan, but you can also try your broker’s platform before buying.
They are funded with simulated money, so you don’t have to worry about risking your hard-earned capital. Demo accounts are the ideal place for trial and error.
Rules & Restrictions
You must know the rules for day trading options in your country and markets. For example, there are FINRA day trading rules on options in the US. They stipulate that if you meet the ‘pattern day trader’ criteria (invest more than four times in five business days), you must hold an account with at least $25,000. So, if you haven’t got significant capital to start with, investing may be off the cards for now.
However, whilst pattern day trading does apply to options in the US, many other countries do not have such barriers.
In some countries, you may need to consider taxes. How will your profits be taxed? Will they be considered personal, business, speculative or non-speculative? Your tax obligations can seriously impact your end-of-day profits. So, find out what type of tax you will have to pay and how much.
For more guidance, see our taxes page.
One of the best day trading options tips if you’ve got an effective strategy is to consider using automated software. Once you’ve programmed in your criteria, an algorithm will execute trades on your behalf. This can allow you to make far more investments than you could manually. However, it is important to note that this is a tool best employed when you have already nailed down a consistently effective strategy.
For more guidance, see our software page.
Whether you are day trading using weekly options or you’re trading 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 investors advise using a 1% rule. The rule stipulates that you should never risk more than 1% of your account balance on a single trade. So, if you have $40,000 in your account, the maximum position size you would take is $400. Once your strategy has consistent results, you can consider increasing your risk to between 2-5%.
Take Away Points
As an online trader, you have two objectives. Firstly, make money. Secondly, do so with minimal risk. Options are the ideal instrument for traders looking for both. When day trading nifty options, you can set clear limits on risk and have the ability to buy and sell contracts multiple times to profit again and again from stock price movements. Products offer advantages that other financial instruments simply do not.
On top of that, there are always attractive picks, whether you’re day trading S&P 500 options or Delta and SPY options. As the popularity of traditional options grows, make sure that you utilize all the resources around you to assert a competitive edge. That means diving into books, 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 bring returns.
What Exactly Is A Chooser Option?
After purchasing the option, the holder can pick whether it is a call or a put. It is more adaptable than a standard vanilla choice.
How Do Options Affect Buyers And Sellers?
Options are financial derivatives that provide the buyer the right to buy or sell the underlying asset at a specific price within a predetermined time frame.
What Exactly Is A Stock Option?
A stock option grants an investor the right, but not the duty, to buy or sell a stock at a predetermined date and price.
What Is The Taxation Of Options?
Call and put options usually are taxed, dependent on how long they are held. They are subject to capital gains taxes in the UK, for example. Aside from that, the details of taxable options are determined by their holding duration and whether they are naked (the option writer does not hold the underlying position) or covered (the investor selling call options owns an equivalent amount of the underlying security). Consult a tax advisor for more guidance.
What Does It Mean To Exercise An Option?
Exercising an option entails carrying out the contract and buying or selling the underlying asset at the specified price.