In the past day trading options was not part of most traditional intraday strategies. However, times are changing and today traders make considerable money using options. This page will highlight the benefits and drawbacks of trading on options, as well as covering types of options, how to get setup, and top tips.
What Are Options?
The straightforward definition – an option is a straightforward financial derivative. This legal contract affords you the right to buy or sell an asset during or within a pre-determined date (exercise date). If you are the seller you have an obligation to meet the terms of the transaction. These will be to either sell or buy if the buyer chooses to ‘exercise’ the option prior to the expiration date.
Options for day trading span across numerous markets. You can get stock options, ETF options, futures options, and more. These traditional options are also known as ‘vanilla options’.
What Is An Option Contract?
You’ll be afforded a number of rights with an options contract. Each contract should include details of the following:
- Type of option (call or put option)
- Underlying security
- Strike price (the price at which you can exercise the option)
- Unit of trade (the number of shares)
- Expiration date (the last trading day for exercising your option)
Options are often classed as complicated, risky investments, and that puts off many aspiring day traders. However, there are just two main classes of options.
- Put – These selling options allow you to sell a stock at a specific price.
- Call – These buying options allow you to purchase a stock at a specific price.
Setting aside the two main classes, there is a long list of different markets and options available. Although not all are suitable for day trading, the list includes:
- Stock options
- Index options
- Mini options
- Mini Index options
- Options on futures
- Weekly SPY options
- OEX options
- ETF options
- S&P 500 options
- IRA accounts
- E-Mini options
- ES weekly options
- QQQ options
- Deep in-the-money (ITM) options
- Crude oil options
The Underlying Asset
Usually, you will find that most options are based upon shares in publicly listed companies, Twitter and Amazon, for example. However, there is a growing number of options 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’s important to be aware the contracts are based on 100 shares of the underlying stock. The exception to this rule is when adjustments take place as a result of 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
A lot of people swiftly realise there are numerous 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 available options. You’ll also find the trading rules 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 a number of reasons you can make serious money trading options. Even putting financial remuneration to the side, day trading with options appeals for several attractive reasons.
- Low-cost strategy – Day trading in options gives you the opportunity to enter and exit positions quicker and with less risk than other securities, such as stocks and mutual funds. It’s also significantly cheaper to purchase an option than to buy the underlying asset, the shares of the stock, for example. So, you can control the same number of shares with far less capital.
- Diversity – Because options are so much cheaper than buying the actual stock, you can benefit from an increased number of investment opportunities. Your capital will go further, increasing your profit potential.
- Greater benefits – When the stock moves you can benefit even 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. Therefore, you can profit more and in less time with an option.
- Options can succeed where other sectors fail – Whilst some sectors of the market 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 great profit potential. The best part though – accessibility. You can start day trading with options from anywhere in the world. All you need is an internet connection.
Despite the numerous benefits, there are certain challenges that come with trading in options. Fortunately, all the obstacles listed below can be overcome.
- Wide bid-ask spreads – In comparison to stocks, the 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 option 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 trading plan accordingly.
How To Start Trading Options
Day trading options for beginners requires following a few straightforward steps.
Open A Brokerage Account
Your 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. You’ll need to consider a number of factors when making your choice.
- Costs – Compare the commissions between different brokers. You’ll even find some brokerages that offer zero commission fees for trading options. Also, check their fee structure is straightforward and there are no hidden costs. You must make sure you’re getting competitive spreads.
- 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 the capital you actually have. A margin account, however, will allow you to borrow money from your broker to capitalise on trades. 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 significant 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 whilst on the move you may also want to investigate their mobile and tablet apps.
For more guidance on making the right decision, see our brokers list.
Once you’re set up with a broker and you’ve got your very own trading room ready to go, you’ll 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, there are a couple of essential components most strategies will need.
Charts & Patterns
Unless you’re trading using the news, you’ll probably utilise charts and patterns to predict future price movements. They work on a simple hypothesis, that history repeats itself, and you’ll find many a rich trader who agrees wholeheartedly with that statement.
Your chart will require the best indicators for trading options. These vary from strategy to strategy, but they include:
- Put Call Ratio Indicator
- Money Flow Index
- Open Interest
- Relative Strength Index
- Bollinger Bands
You’ll find that pattern trading with options takes hard work and practice. You’ll need to iron out any creases and try a number of 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 though, but also when you set up for the trading day ahead. Options strategies that work usually have a trader behind them who is up bright and early.
For example, you may want to be up as early as 06:00 am ET if you want 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. If you know this you can also know if most stocks will open up or down when the US market opens at 9:30 am ET.
It’s worth bearing in mind that the US often dictates the direction of the world markets. So, it’s sensible to wait an hour for the market to settle somewhat before entering your first trade.
Day trading on options requires careful analysis and significant time. Make sure you’re willing to put in the hours if you want to generate substantial profits.
This is one of the basic options strategies that work. If the market is on the rise you will buy calls or sell puts. If the market is on the decline you’ll 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 one such example.
Let’s go back to the E-mini. You’d be patient in that first hour and then you’d look to 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’d 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 traded in the right direction. If so, you’d place a stop at half the value of the option you bought. So, if you bought it at $10.00, you’d place the stop at $5.00.
If the market turns then get out. There are plenty more opportunities out there. However, if the trade is looking promising then you’d 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 to the other side of the open by around 8-12 cents.
If it continues to look promising you can re-evaluate again 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
Even with nifty options day trading techniques, you can always benefit from invaluable tips. From risk management and stock options tips to education and rules around tax, below you will find top tips that could keep you firmly 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 free download and considered one of the most useful resources out there. However, you should also consider the following:
- Books & Ebooks
- Chat rooms
- Video tutorials
- PDFs (e.g. Tom Demark day trading options pdf)
It can be difficult to resist the urge to throw your hat into the ring 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 you buy.
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
It’s important you are aware of the rules for day trading options in your country and markets. For example, in the US, there are FINRA day trading rules on options. The rules stipulate that if you meet the ‘pattern day trader’ criteria (trade 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, then trading 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 other countries, you may need to consider taxes. How will your profits be taxed? Will they be considered as personal income, business income, 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 speed up trading times, plus it can allow you to make far more trades than you could manually. However, it’s 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’re day trading using weekly options, or you’re trading daily AAPL options, a risk management strategy is essential. This will help you minimise your losses and ensure you always get another crack at the market.
Many experienced traders 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 turns consistent results then you can consider increasing your risk to between 2-5%.
Take Away Points
As a day trader, you have two objectives. Firstly, make money. Secondly, do so with minimal risk. Options are the ideal instrument for day traders looking for both. When day trading nifty options, you have the ability to set clear limits on risk, and the ability to buy and sell the options multiple times to profit again and again from stock price movements. They offer advantages that other financial instruments simply do not.
On top of that, whether you’re day trading S&P 500 options, or delta and spy options, there are always attractive picks. As popularity for traditional options grows though, it’s important you utilise all the resources around you to assert a competitive edge. That means diving into books and online tools, as well as 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 lined with gold.