Options Trading FAQ’s

Last updated on May 14th, 2020

We held our live 2 day Options Trading For Income Crash Course this past week where we walked through how we use our entire options toolbox on a weekly basis.

If you missed that training (free) I have included links below to the material which you can take advantage of:

Click Here for Options Crash Course Day 1 Training

Click Here for Options Crash Course Day 2 Training

Many of these questions were ones that we hear on a weekly basis from traders looking to enhance their options trading.

 

NetPicks Frequently Asked Options Questions:

I put together a list of Frequently Asked Questions and stock options trading tips which cover many key areas that newer options traders get hung up on.

 

What are the benefits of trading options?

  1. Options offer great leverage. You are able to control 100 shares of stock for a few hundred dollars or less.
  2. Options can allow us to make money in many types of market conditions. Even then stocks are moving sideways.
  3. There are options trades that can allows us to make money 5 different ways.
  4. Trading options can be done in as little as 10 minutes a day.
  5. Options trading allows us to control our risk better than any other financial instrument out there

 

What options broker is best to use?

While there are many options brokers available these days, there are two that we recommend above the rest. The first is TastyWorks (https://www.tastyworks.com) and TD Ameritrade (https://www.tdameritrade.com). Both of these brokers offer great platforms with low commission rates.

For those of you with busy schedules that like to trade from a mobile platform, both of these brokers also provide mobile apps to trade from.

The benefit of TastyWorks is they offer a flat $1 per contract commission for an options trade. They also don’t charge a closing commission so you will only be paying to enter the trade. They also cap their commissions at $10 per trade ($10 per leg on a spread).

This can lead to big savings if you are trading bigger position sizes.

Finally, TastyWorks doesn’t have different levels of accounts like most other brokers. If you open an account with them you can trade any options strategy you want (long calls and puts as well as spreads). For these reasons, TastyWorks is our broker of choice.

 

Should I open a margin or cash account?

We prefer using a margin account as it will allow us to trade vertical spreads. While you can open a cash account with less capital, you will be limited to buying calls and puts. This will greatly limit your flexibility in different market conditions.

Most brokers require a $3,000 starting account size to open a margin account. Cash accounts can be opened with as little as $50.

 

What is the pattern day trading rule (PDT) and who does it apply to?

Margin accounts under $25,000 are subject to the pattern day trading rule. This rule limits the number of day trades you can take. You are allowed 3 day trades in a 5 day stretch. Cash accounts are not subject to this rule.

If you plan on day trading options with an account size less than $25,000 you will be better off with a cash account.

 

How much capital should I start trading with?

We recommend starting with a minimum of $3,500. While you can start with less than this it becomes much more difficult to control the risk if you do. Ideally, we want the risk to be kept to 2-5% of your account per trade.

 

Should I day trade or swing trade options?

We find it much easier to swing trade options. We classify a swing trade as holding a position for anywhere from 2 days on out to 3 weeks.

Day trading options can be difficult as it takes more time on a daily basis and also becomes less forgiving if the stock doesn’t move in your favor immediately.

 

Which options strategy is best?

The beauty of options trading is the flexibility that they offer as they allow us to do things that can’t be done with any other financial instrument.

The 3 strategies that we recommend all options traders use are:

  1. long calls and puts
  2. debit spreads
  3. credit spreads

We cover these strategies in detail including step by step criteria for each trade type in the free Options Trading For Income Crash Course which you will find links to above.

 

Is volume or open interest more important when trading options?

Liquidity is a very important topic when trading options. The more active the options are the easier it will be to get filled on trades and at good prices.

Volume indicates the number of contracts traded that day. Open interest will tell you the total number of option contracts that are outstanding. These are contracts that have been traded but have not been closed by an offsetting trade or an exercise or assignment.

Unlike trading volume, open interest is not updated during the trading day.

Ideally, we like to see good volume and open interest in the options that we trade. However, open interest is more important to us as it indicates those options have been active over a period of days. This will typically lead to tighter bid/ask spreads on the options, which means we will be able to get in and out of our trades at better prices.

 

Are weekly or monthly options best to trade?

We prefer to use options that have between 20-60 days left to expiration. This could be a mix of weekly options that have at least 20 days left to expiration along with monthly options. We find the monthly options easier to trade in most cases as they will have better liquidity meaning the volume and open interest are higher.

We are open to trading the shorter duration options but like to see the VIX in the upper teens or low twenties when doing so.

 

Should I trade In The Money or Out Of The Money options?

While the out of the money options are attractive due to being cheaper, we much prefer trading the in the money options. They provide a higher quality position which will increase your odds of success. The out of the money options are cheap for a reason because they have a lower probability of success as there are more factors working against them.

When buying options, we prefer to buy the options that are 1-2 strikes in the money from the entry point on your chart. This will give us the most bang for our buck.

 

Stock movement vs Implied volatility vs Time decay

All 3 of these can have a big impact on the prices of an option.

When buying options, you need a big enough directional move in the stock in your favor and it has to happen quickly enough to offset the time decay and potential movement in volatility. I’m not opposed to buying options, but you need a lot to go right in your favor to make money. If the stock doesn’t move fast enough or volatility drops too much while you are in the trade, you won’t be as profitable.

Trading credit spreads allows you to put on a trade where you are benefiting from time decay adding up and volatility decreasing. You are able to stack the deck in your favor by placing a trade that has 5 ways of making money.

Stock movement, implied volatility, and time decay are all crucial factors to take into consideration when placing an options trade. Ignoring one of these factors can lead to very inconsistent returns over time.

We talk about this in more detail in our free Options Trading For Income Crash Course at the links to above.

 

Should I use limit or market orders when placing my trades?

We highly recommend using limit orders when placing your options trades. When you use market orders you lose control over where you get filled at. This can lead to giving up too much on the fill prices. Market orders should only be used as a last resort option.

When using limit orders, we like to place the orders at the mid price between the bid and ask prices. While this doesn’t guarantee you will get filled on a trade at these prices, it’s a good place to start.

If you are placing a buy order and can’t get filled at the mid price then you can adjust the order price higher by a few pennies. If you are placing a sell order and can’t get filled at the mid price then you can adjust the order price lower by a few pennies. Doing so will increase your odds of getting filled.

If you have any other options questions that we can help with feel free to email me directly at mike@netpicks.com.

 

2 Responses to “Options Trading FAQ’s”

  1. Kathryn R Veith

    Interested in understanding options spreads.

    Reply

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