Day Trading Using Options

Day trading using options can be a great way to capitalize on short-term stock movements while limiting your risk exposure. With the right strategies and tools, you can make the most of your day trading experience by taking advantage of the leverage and loss-limiting capabilities that options provide.

In this guide, we will discuss how to use near-month in-the-money options for day trading, the benefits of doing so, and how to maximize your returns.

Overview of Options Trading and Day Trading

Options trading is where you buy the right to buy or sell a stock at an agreed-upon price by a certain date. Unlike stocks, however, options have time limits; they expire after a certain period, usually one month or more but many do choose very close expiration dates.

Day trading involves taking positions in the market that are opened and closed quickly, sometimes within minutes. This allows traders to quickly capitalize on short-term stock movements and make a profit.

Advantages of Options Trading for Day Traders

Options trading offers several advantages to day traders. First, options have the potential to provide a greater return on investment than stocks since they come with leverage and can be sold at a higher price than what was paid for them.

Secondly, the time value component of options means that you can limit your losses if the underlying stock does not move in your favor.

Finally, when trading options, you don’t need to risk as much capital upfront as you would with stocks because the cost of buying and selling options is significantly lower. This means that day traders can get into and out of positions quickly without having to commit too much capital upfront.

Let’s take a closer look at each of these advantages.

Potential for Greater % Returns Than Stocks

One of the biggest advantages of options trading is that options have the potential to provide a greater return on investment than stocks. This is because options come with leverage and the contracts can be sold at a higher price than what was paid for them.

For example, let’s say you buy a call option on ABC stock for $1 per share with a strike price of $100 and ABC stock is currently trading at $105 per share. This means that you have the right to buy 100 shares of ABC stock at $100 per share anytime before the option expires.

If you exercise your option and sell your shares if the stock hits $110.00, you will make a gross profit of $1000 ($10 per share increase x 100 shares).  Compare this to buying ABC stock outright at $105, which would only give a $500 profit if ABC stock increased to $110 per share.

There are other factors involved of course and this is just a high level view.

Options provide leveraged profits without having to put down more money upfront!

Limited Losses With Time Value Component

Another big advantage of options trading is that the time value component of options means that you can limit your losses if the underlying stock does not move in your favor. Time value is how much of the premium is based on the time remaining in the option contract.

The more time that is left before an option expires, the greater its value. The reason is that investors are usually willing to pay a higher premium for longer contracts so that they have more of a chance to profit from any positive changes in the underlying asset.  Time really is money in options trading.

Trade Options Without risking too Much Capital Upfront

Another advantage of options trading is that you don’t need to risk as much capital upfront as you would with stocks because the cost of buying and selling options—the premium—is significantly lower.

For example, let’s say you want to buy 100 shares of XYZ stock but it is currently trading at $105 per share and you only have $10,000 to invest. If you were to buy XYZ stock outright, you would only be able to purchase 95 shares because each share costs $105.

However, if you were to buy put options on XYZ stock with a strike price of $105 per share and a premium of $2.00, you could purchase 10 contracts for $2 per share or $2,000 total.

Problems with Day Trading Using Options

There are a few challenges that you should be aware of before you start day trading options.

Expiration Dates

One of the biggest challenges of day trading options is that they have an expiration date. This means that if the underlying stock does not move in your favor before the option expires, the option will become worthless.

To overcome this challenge, you need to be aware of the expiration date of your options and trade accordingly. If you are holding an option that is close to expiration and the underlying stock has not moved in your favor, it may be time to cut your losses and move on.

Lack of Volume

Another issue that can impact day traders is the lack of volume. Liquidity is important when you are trying to get in and out of a position quickly. If there is not enough volume, it may be difficult to get out of your position at the price you want.

This challenge can be overcome by doing your research and only trading options with sufficient volume. You can check the volume of an option by looking at the bid-ask spread. The narrower the spread, the higher the volume and liquid an option is.  Of course, you can also check the volume column.

Complexity

Finally, another challenge of day trading options is that they can be quite complex. This is especially true if you are new to options trading. Some traders just don’t have the level of understanding required to trade options successfully. This can lead to costly mistakes being made.

To overcome this challenge, it is important to do your research and understand exactly how options work before you start trading them. There are many resources available online that can help you learn about options trading. Utilize these resources so that you can trade with confidence and avoid making costly mistakes.

Time Value Component of Option Premium

Option premiums are made up of two components: intrinsic value and time value. Intrinsic value is the difference between the option’s strike price and the current market price of the underlying stock. Time value is the amount that you pay for an option beyond its intrinsic value which reflects the risk of expiration and other factors associated with the option.

As the expiration date approaches, the time value component of an option’s premium begins to deteriorate and day traders need to take this into account when entering and exiting positions.

Bid-Ask Spreads

When trading options, there is a bid-ask spread which refers to the difference between the price at which an option can be bought and sold. The wider this spread, the more difficult it may be to get out of a position quickly as buyers may not be willing to pay the ask or sellers are not willing to part with their options at the bid.  At Netpicks, we start with the mid-price between Bid/Ask until we get filled.

Strategies for Day Trading Options

There are a variety of strategies that can be used when day trading options. One popular strategy is to buy near-month in-the-money (ITM) options with the expectation that they will generate a large move in price quickly. This strategy carries a high degree of risk as option premiums have an expiration date and prices can move quickly.

Another strategy to consider is writing out-of-the-money (OTM) options where you would collect the option premium for selling the option but can potentially incur losses if the underlying stock does not move in your favor. This strategy also carries a high degree of risk and requires an understanding of how prices may react to different market conditions.

Finally, some traders opt for strategies such as spread trading which involves buying and selling multiple options with different strike prices. This type of strategy requires a knowledgeable understanding of implied volatilities and can be complex to execute successfully.

Day Trading Contract Specifics

Day trading options are best done with near-month in-the-money options of liquid stocks. These options have little time value and a delta close to 1.0, making them ideal for short-term trading.

As we approach expiration, the option’s premium is increasingly based on its intrinsic value, allowing us to closely track the underlying stock’s movements.

Near-month options are also more heavily traded and liquid than longer-term ones, meaning there will be smaller bid-ask spreads. For day trading purposes, these features make near-month in-the-money options of popular stocks the ideal choice.

What Is A Lotto Play With Options

A lotto play with options is an aggressive strategy that involves buying out-of-the-money (OTM) options in the hope of making a quick return. This type of trading, while potentially profitable, carries a high degree of risk and should only be attempted by experienced traders who understand the risks involved and have the financial resources to support the potential losses.

What Are The Risks Of A Lotto Play With Options?

Since a lotto play with options focuses on OTM options, there is a higher chance that these options will expire worthless. This means that if the underlying asset does not move in the desired direction, or if it only moves slightly in the desired direction, the trader will lose the entire amount invested in the option.

For this reason, traders must have a sound exit strategy in place before entering into any lotto play with options trade.

A lotto play with options may be right for you if you’re an experienced trader who understands the risks involved and has the financial means to weather any potential losses. However, this type of trading is not for everyone, and even experienced traders can find themselves in over their heads if they don’t have a sound exit strategy in place. If you’re thinking about employing a lotto play with options strategy, make sure you fully understand all of the risks involved before taking any trades.

Quick Wrap

Day trading options involve strategies such as buying near-month in-the-money (ITM) options, writing out-of-the-money (OTM) options, and spread trading.

Near-month-in-the-money options of liquid stocks are the ideal choice for day trading due to their little time value and delta close to 1.0.

A lotto play with options involves buying out-of-the-money (OTM) options in the hope of making a quick return but carrying a high degree of risk.

If employing this strategy, it is important to have a sound exit strategy in place before entering into any trades.

Day trading options may be right for experienced traders who understand the risks involved and have the financial resources to support any potential losses.