by Amanda Harvey
Stock option day trading is the same in essence as other types of day trading, insofar as the basic premise is that the trader enters and exits each trade taken within the same trading day. As with any type of day trading, the trader of stock options engaged in day trading seeks to generate quick profits, thereby freeing the capital to be invested repeatedly within a short period of time. Increases are often fairly small, and the way that the trader attains substantial returns is by executing a large number of trades.
Stock option day trading is more time consuming than longer time-frame styles of trading, and therefore is often considered as an occupation by those traders involved. The market must be monitored closely for short-term movements in price which may result in an increase in the value of options held. Sometimes a trader will repeatedly trade the same stock option; however, this may result in being classified as a pattern day trader which incurs specific regulations that a trader must be aware of.
Points to Consider For Day Trading Options
When engaging in stock option day trading, it is important to select options with high liquidity, meaning that they are trading at a high volume. This helps to ensure that the trader will be able to sell the options easily and at a reasonable price within the time frame that they wish to adhere to. Selecting options that are based on a highly liquid underlying stock is one way to achieve this goal, and the length of time before expiration of the option, as well as relationship to the strike price are also key factors.
When considering length of time before expiration, the most popular choice for stock option day trading is options due to expire at the end of the nearest month. These options are known as ‘near month’ options, and they have less time value built into their premium, which suits the purposes of the day trader.
Near month options which are also ‘in-the-money’ are a good selection for the option day trader, as they have already surpassed their strike price, and can be exercised. Buying an in-the-money option allows a trader to capitalize immediately when the desired amount of increase is attained.
Delta is another consideration when choosing options suitable for day trading. Delta measures the relationship in price movement between an option and its underlying asset. For an options day trader, it is desirable to select options with a Delta close to 1.0 for a call option, and -1.0 for a put option, as this offers the best probability of the option attaining sufficient movement in price for the trader to achieve their target.
Cautions for Stock Option Day Trading
Compared to the trading of stocks, options trading can face the obstacle of lower liquidity, and this may translate into a wider bid-ask spread. This means the gap between price being offered and the price being asked for the sale of an option. If this is encountered when day trading options, the limited amount of gain which is usually attainable is reduced further, making the trade unrewarding.
Buying options with a greater length of time before expiration is a mistake that a beginning day trader could make, without realizing the proportion of time-value that is contained within the premium. As the intention is not to hold on to the option, but to sell it again within the same day, the trader must be aware that only the intrinsic value of the premium will increase with movement in the price of the underlying, and that the time-value component will not rise. This means that rather than attaining a 10% increase on the premium they paid, they might only receive a 10% increase on half the premium.
With careful selection of options, and an understanding of the possibilities and pitfalls of stock option day trading, a trader may certainly find this a viable arena for benefitting from trading stock options. The limited risk of trading options being confined to the premium paid, as well as the rapid turnover of capital created by day trading and the avoiding of overnight gaps down, can make stock option day trading a rewarding style of trading for the option trader.