Day Trading Options – Rules & Strategies for Beginners
Options are a financial derivative. This means that the value of an option contract is dependent on the movement and price of the underlying asset. The underlying asset can be of many different types, including stocks, bonds, indices, commodities, and currencies.
There are two types of options – the Put and the Call. The put allows the holder of the contract to sell an asset for a predetermined price on a certain day, while the call gives the holder the option to purchase an asset for a predetermined amount, called the strike price, on a certain date. For both types of options, the holder of the option contract has the option to execute the contract by the option expiration date or let the contract expire worthless.
A call option is considered “in the money” and has intrinsic value if the strike price of the contract is lower than the price of the underlying security. This means that the holder of the contract has the option to purchase the asset a price below the market. A put option is considered to be “in the money” and has intrinsic value if the strike price of the contract is higher than the price of the underlying security. This means that the holder of the contract has the option to sell the asset at a price above the market.
Options are traded on exchanges like many other assets. The Chicago Board Options Exchange (CBOE) is currently the largest and most well-known international exchange, but there are many other exchanges around the world.
Day Trading Options
Day trading options shares some important similarities to day trading the underlying assets. Because the value of an option contract is dependent on the movement and price of the underlying asset, this presents the opportunity for a discerning trader to profit off on the price fluctuations of the underlying asset – this is just like how a trader would profit by trading the underlying asset.
A trader who is bullish on an asset would buy a call. If the price of the underlying asset rises, the price of the call option contract will increase in most cases.
A trader who is bearish on an asset would buy a put. If the price of the underlying asset decreases, the price of the put option will increase in most cases.
Day Trading Options for Beginners
Options are complex instruments. Many traders purchase options with the hopes of multiplying their investment. The moniker “low risk, high ceiling” is often thrown around – beginner traders may interpret this as encouragement to treat options trading as the lottery. This is not the correct approach to trading options successfully and maintaining a positive P&L. As with trading any other assets, it is important to follow certain processes and strategies and maintain discipline while trading.
Are Options More Risky Than Stocks?
It depends! Just as with stocks, there are riskier strategies and more risk-averse strategies. In both cases, leverage can be used to increase both risk and reward.
Options have two main uses: Hedging and Speculation.
Hedging with options is used to minimize the risk and provide downside protection for an existing position. An investor bullish on a certain stock but concerned about downside may purchase shares and protect potential downside with a put option.
Speculative trading occurs when a trader invests with the goal of profiting off market fluctuations. Options can be either riskier or less risky than investing in the underlying asset – it all depends on the strike price and maturity.
Day Trading for a Living
Day trading options for a living is possible. It is a lucrative but difficult career path, and is very different from a typical day job.
There are some key differences in a day trader’s lifestyle versus a typical individual’s lifestyle.
- A day trader can work from any location as long as they have a fast internet connection and computer. No office space required, and no commuting. This also means that a day trader can choose to live in a lower cost part of the world in an effort to increase real wages.
- A day trader can choose to work as many or as little hours as they like. There are options markets all around the world, so there will always be exchanges that a trader can monitor and trade on.
- No corporate jostling and no boss. A day trader doesn’t have to deal with other co-workers vying for the same promotion. They don’t even have to deal with having a boss who has the last say on what they do. A day trader controls what they look at, what they trade, and how they trade.
- There are no promotions and there are no bonuses. A day trader is paid off their own skill and do not receive the financial luxuries of working in a corporate environment.
- A day trader looks at the markets for long periods of time and can struggle with boredom. The vast majority of market movements do not align with a trader’s strategy, meaning that a trader has to stay vigilant in order to identify the opportunities that do present themselves. A distracted trader can easily miss an opportunity for profit if they are not quick to execute the trade.
- A trader can make thousands of dollars one day and lose thousands of dollars the next. There is very little stability in a trader’s income.
- Every hour a trader takes off work is an hour that a trader isn’t making potentially profitable trades.
Can You Lose More Than You Invest With Options?
A day trader has the potential to lose all of the premium that they invest. As with day trading of any kind, it is important to limit risk to 1-2% of an account per trade. When investing in this fashion, a day trader can still make profits off their trades while preventing their account from being wiped out by losing trades.
Options Trading Rules
In order to day trade options in the US four or more times a week, an individual is required by FINRA to maintain an account balance of $25,000. If a trader’s account falls below the $25,000 threshold then the trader will not be allowed to day trade until the account is once again raised above the limit.
Different countries have different regulations set up around day trading options. It is important for a day trader to become familiar with these regulations before attempting to trade in a certain country.
It is also important to check the rules set by the broker for an options trading account. These rules can vary significantly between brokers.
Intra-Day Options Trading Strategy
Again, it is paramount that a day trader does not risk more than 1-2% of their account value per trade.
For all strategies, it is important to keep the following in mind:
- How liquid is the option that the trader is observing? Larger bid-ask spreads can eat into the profit the trader stands to make off a certain transaction.
- How volatile is the price of the option? Is there enough intra-day volatility for a day trader to profit after commission and fees?
For intra-day options trading, it is fundamentally important that any option traded has high liquidity. It is also recommended, when not trading near major announcements, that a trader stick with options that are near expiry and are “at the money”, known as ATM – options that are ATM have a strike price that is identical or very close to the current market price of the underlying asset. When trading ATM, price fluctuations can push the option contract in and out of the money, resulting in significant price fluctuations in the contract price that the trader can exploit.
It is another strategy, when trading intra-day, to trade near major announcements. Typically, traders utilise strategies such bull and bear call and put spreads, straddles, strangles, and other strategies based on how bullish or bearish they are on a certain asset. Each of these strategies has a time and place for use, and a beginning options day trader should become familiar with how each strategy works.
What Is The Riskiest Option Strategy?
The riskiest options day trading strategy is the short call. This occurs when an individual sells a call without owning the underlying security. If the price of the underlying security falls, the trader who made the short call profits. However, the trader also faces unlimited upside exposure, making this the riskiest strategy that should be used carefully.
A similar strategy that lowers risk is the covered call. In a covered call the trader owns the underlying asset and therefore limits upside risk.
Options Trading as a Career
There are many traders who make options trading their careers. Career options day traders should be able to be decisive, handle loss well, and separate emotions from decision making while trading.
Most beginning traders will not be successful early. It takes time, effort, and commitment to become an options day trader. Despite the initial difficulties, becoming a skilled options day trader is a path that is very much worth pursuing.
What Is A Day Trader Salary?
Skilled day traders can make upwards of 5% of their investment capital per year. When compounded over a year, this amounts to gains of almost 80% a year!
While beginning traders shouldn’t expect to make these kind of gains, these numbers can be a goal to work towards. Skilled traders with a unique niche can stand to make even more than these numbers listed above.gh