Can You Day Trade Options?
When you’re a day trader, it’s important to find ways that you can make the most profit. Day trading options gives you the chance to gain large profits if there’s a big movement in a stock’s price. As opposed to trading stocks, trading options lets you cut losses more easily while also letting you take advantage of a lower initial investment. Use this guide to learn more about options and options day trading, whether or not you can day trade options, and why you should consider day trading options to help you earn a profit.
- Options refer to financial contracts that grant you the right (but not the obligation) to buy or sell an asset or security by a pre-set date for execution.
- Options are a derivative of an underlying asset. This means you don’t have to pay the asset’s upfront cost.
- When you day trade options, you buy and sell options many times throughout the day to earn small profits. This trading strategy gives you the option of a greater rate of return and can help day traders reach their financial goals.
What Are Options?
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Options refer to financial contracts that grant you the right (but not the obligation) to buy or sell an asset or security by a pre-set date for execution. An options contract stipulates the type of option, the underlying security, the strike price, the unit of trade, and the expiration date. The strike price refers to the price at which you can exercise the option, while the unit of trade refers to the number of shares. The expiration date is the last day you can buy the stock at a set price. It’s also worth noting that an option contract’s value changes as the underlying asset’s price changes.
Essentially, options are a derivative of an underlying asset. This means you don’t have to pay the asset’s upfront cost. However, you pay or earn a premium for taking part in the underlying asset’s price movements. As a seller, you’re obligated to follow the terms of the transaction. This means you have to sell or buy the asset if the buyer chooses to execute the option before the pre-determined date.
Some examples of options include stock options, futures options, and exchange-traded funds. However, there are two main types of options:
- Call: This type of option lets you buy a stock at a predetermined price. When the stock price increases, the value of the option goes up.
- Put: A put refers to an option that allows you to sell a stock at a predetermined price. When the price of the underlying stock goes down, the put option’s value decreases.
Can You Day Trade Options?
Yes. In fact, day trading options has become increasingly popular over the years.
When you day trade options, you buy and sell options many times throughout the day to earn small profits.
Overall, this trading strategy gives you the option of a greater rate of return and can help day traders reach their financial goals.
Why Should You Trade Options?
Trading options gives you the opportunity to earn a good amount of money. Here are some of the benefits that come from trading options:
- Diversity: Not only are options cheaper than buying the stock, but you also have a greater amount of investment opportunities. With greater capital, you can increase the amount of profit you make.
- Simplicity: Unlike buying and selling stocks, trading options is much simpler. All you have to do is find an option you want, select a strike and expiration, and buy.
- Hedging: When you trade options, you have the ability to hedge, letting you work both sides of the market by buying and selling both call and put options. This allows you to protect your capital should something go awry.
- Lower cash requirement: As a stock trader, you need a good amount of cash to help you obtain a decent amount of earnings. When you day trade options, you can start with much less cash thanks to leverage. Overall, it’s much cheaper to buy an option than to buy an underlying asset or stock shares.
- Less risk: With an options contract, you can choose whether you want to buy in, buy out, or neither. Because of this, trading options has the potential to be less risky than trading other options.
- Ease of entry and exit: When you trade options, you can enter and exit positions more quickly than you can with stocks or bonds.
Drawbacks of Trading Options
While trading options comes with several benefits for day traders, there are also some drawbacks to consider. However, to avoid them, all you need to do is modify your day trading plan accordingly. Here are the disadvantages that come from trading options:
- Wider bid-ask spreads: Because of the reduced liquidity in options markets, options offer a wider bid-ask spread compared to stocks. When this happens, it can reduce the profit you receive from a day trade because you’re buying at the higher price of the spread and selling at the lower price.
- More research: When you day trade options, you need to spend more time preparing for the trading process. This is because you never know which stock names will be active each day, requiring you to look at a bigger watch list.
- Reductions in price movement: In some cases, you may face limited price movement by the time value element of your option premium. Even if the value goes up with the price of the underlying asset, the loss of time value affects the overall gain.
Tips for Day Trading Options
If you’re new to day trading options, it’s important to learn all you can about this strategy. Heeding advice can help you make the most of it and gain the most profit at the end of the day. Consider these tips for day trading options:
- Create a solid trading strategy. When you day trade options, it’s important to go in with a strong strategy that can help you throughout various market conditions. A good strategy can also help you determine when it’s best to avoid putting money into the options market.
- Find an affordable broker. Since broker fees and commissions can add up, make sure you find a broker who’s within your budget. Many brokers even offer commission-free day trading for options and other assets.
- Use technical analysis. While this type of analysis helps you better understand a stock’s movement, it can also help you find desirable options trades.
- Get educated. Before you start day trading options, use educational resources like books, video tutorials, forums, and podcasts to your advantage. Even if you have experience with day trading options, immersing yourself in information can inspire you to refine your day trading strategy and give you the motivation you need to seek out financial gains.
- Stay focused and patient. Since trading moves fast, it’s important to stay on task in order to make your entrance or exit at the right time. Be sure to monitor the charts closely. In addition, aim to wait for the right opportunities instead of trying to make a huge win on every movement in the market.
Now that you know more about day trading options, consider if this is the right strategy for you. If you decide to go this route, be sure to do your research to help you gain the most profit from this type of day trading. As time goes on, consider refining your strategy to better meet your needs and the overall market.