Day trading options has become has become increasingly popular in recent years for a number of reasons.
The chance of a much higher rate of return is the main reason. Options offer several other benefits and, if used wisely, are an excellent way to help day traders reach their financial goals.
If you are considering day trading options, you have come to the right place. In the following, you will learn all you need to know to get started, including why you should day trade options, how to trade them, and tips to keep in mind.
What are Options?
Options are contracts that give the holder either the right, but not the obligation, to buy or sell a stock, or other financial instruments at a given price within a given period, usually a few weeks or months.
Types of Options
There are various types of options available for traders and these can be categorized in a number of ways. The two most popular categories of options among traders, and from which all options trades are built, are call options and put options.
- A stock call option gives the holder the right (but not the obligation) to buy a stock from the seller by a certain date (the expiry), for a certain price (the strike price). The value of a call option goes up when the price of the underlying stock price increases.
- A stock put option gives the holder the right to sell a stock at an agreed-upon strike price before the expiry date. The value of a put option goes down when the price of the underlying stock price falls.
Why you Should Day Trade Options
Now that we have covered the basics, let us look at why you should day trade stock options.
- Ease of trading
First, trading options is simple. It’s just like buying and selling stocks. You pick a strike and expiration for the options you want to purchase and hit the buy button!
- Ability to hedge
Trading options also offers you an opportunity to work both sides of the market since you can buy and sell both call and put options. Therefore, you can shield much of your capital in the event that something goes wrong on the short or long side.
- Leverage
Second, options traders can earn a very nice return with just a little bit of money as they are able to take advantage of the leverage options offer.
- Low cash requirement
If you want to generate decent earnings as a stock day-trader, you will most likely need to start with a decent amount of cash. But you can start with much less money if you day trade options instead of stocks, thanks to leverage.
How to Day Trade Options
Options trading was once considered the domain of the Wall Street elite. However, the proliferation of online brokerages now means that all that anyone needs to wade into options trading these days is a small starter fund and little bit of know-how.
To day trade options you need a few basic tools:
- A laptop or a computer
First and foremost, having two monitors is preferable, but not necessary. The computer ought to have a fast-enough processor and sufficient memory to avoid experiencing crashes or lagging when you run your trading programs.
- An online broker
In order to trade options, you will need to find an online broker that offers options trading like TradeStation or TD Ameritrade.
- A reliable and relatively fast internet connection
Options day traders ought to use at least an ADSL or cable type internet connection. Although speeds tend vary across these types of services, it is important to strive for at least a mid-range internet package. You can find more information on internet speed here.
Tips for Trading Options
Here are a few important tips you need to remember in order to become a successful options day-trader.
- Develop a robust trading strategy
One of the worst mistakes day traders make is to get into an options trade without a strategy. If you develop a solid strategy for day trading options, you can use it in many market conditions and to inform you when not to put your money into the options market.
- Pick a broker that fits your budget
Day trading options can be quite expensive when it comes to broker fees and commissions. Thankfully, many brokerages including Charles Schwab and T.D. Ameritrade have begun offering commission-free online trading for options, stocks and exchange-traded funds (ETFs).
- Invest in good options trading education
Before you start trading options, have the specific information needed to win. You need to invest in educational resources that have demonstrated long term results if you really want to increase your chances of success.
Drawbacks to Day Trading Options
While great in many respects, day-trading options does have the following drawbacks:
- Illiquidity: Some thinly traded stock options have wide bid/ask spreads. This means that a day trader will buy at the high price of the spread and sell at the low price of the spread.
- It is also difficult to know when the huge moves are going to happen
- Day trading options also requires more prep work to be done on a daily basis since traders need to look at bigger watch lists of stocks because they don’t know which names are going to be active on a given day
- Finally, if you plan on day trading options, you will have to meet certain margin requirements that are laid out by security regulators.
Bottom Line
Whether mitigating risk, seeking income or just speculating on price movements, people are trading options in record numbers these days.
Day trading options is appealing to some people because it often has the ability to cut losses more easily, and typically requires a lower initial investment.
By combining the potential returns offered by day trading with the benefits of options trading, traders have plenty of opportunities for potential profit.