Day trading options is popular. Many traders see it as one of the most exciting areas of trading.
So what is it that’s so magical about this particular trading market?
It’s popularity is no accident. The extreme volatility in options prices makes the potential attractive. That same volatility can also makes options quite hazardous if mismanaged.
Success in day trading options all comes down to having a proper trading plan. And that trading plan must have robust strategies to see the plan through.
The correct options strategy can and should be simple. Complexity is the enemy when trading options, as it is in any market. Traders who do well manage to keep things simple.
I’ve put together 8 essential tips for success when day trading options. They won’t turn you into an overnight millionaire – at least not a very long-lasting one if it does happen. But you can be sure to improve your performance by following the advice in these tips.
Day Trading Options – Tip #1: Know the cost of high potential returns
Let’s put all our cards on the table. I will admit it too. Options and the potential for quick and outsized profits are attractive.
But volatility is a sharp knife that cuts both ways. High percentage losses go hand in hand with targeting high percentage gains. The roller coaster ride mixes high anxiety with positive euphoria.
Now let’s talk about the hidden cost that many new traders miss. If nothing else changes, options are worth less and less as time goes by because all options expire. It is a characteristic that all options share and it’s called time decay.
The concept of time decay is best understood by comparing selling a bag of ice to selling a pencil. You buy the ice in the morning when the weather is cool. You then expect to sell it at a higher price when the temperature is hotter.
The longer you wait to sell it, the more it melts and the less ice you have to sell. In contrast, pencils don’t melt so the pencil you bought in the morning in still intact to sell later in the day.
Options are like the bag of ice in the example. Buying option contracts means that you are setting a time expectation for your trade. Besides the time expectation, you also have to get the direction right.
One way to reduce the impact of time decay is to trade back to cash at the end of every day. But to do this you need to work it into your strategy. Whatever you choose to do, consider time decay and its effect on your results.
Before trading options, make sure you understand the cost of the high-potential returns. Know your risks and try to limit them. If you play safe, options can be a rewarding trading game.
Day Trading Options – Tip #2: Stay close to the current price
Options are cheaper when they are further away from the current stock price. Options pricing parallels the way insurance works. The price of the premium (or cost of the option) relates to the probability of the event occurring.
“Stay close to the current price when day trading options.”
The further away from the current trading price the strike price of the option is, the lower the price will be. A good example is a stock trading at 30. A call option for 31 is going to cost more than a 32 call option, and in turn, the 32 call option will cost more than a 40 call.
Many see the cheaper prices farther out and see that as the best place to be. They’re wrong. Stick to strikes close to the current stock price.
Staying closer to the strike price increases the chances of profit. There the spreads are always tighter too because it’s where traders focus.
Day Trading Options – Tip #3: Dependable discipline and mental stops
Set mental stops instead of leaving stops in the market. As mentioned above, spreads in options can be quite wide.
A stop order left in the market could execute as the spread widens. It can happen without an actual trade happening at your stop price.
When you use mental stops you prevent this from happening. But heed a big word of caution when dealing with mental stops. Mental stops need dependable discipline and consistent attention to be effective.
A good idea is to write your mental stop level down on paper and pay close attention to price action. If a trade happens there, flatten your position – no questions. Even though it’s a mental stop, you need to follow it as if it was a set-in-stone order in the market.
Day Trading Options – Tip #4: Let puts and calls do the work
Options on stocks and options on futures. Countless strike prices and expiry dates for each one. There’s already plenty of choices to make. This is why day trading options is often best done with long-only strategies.
“Using puts and calls to stay long-only is the safest options strategy.”
Let the calls handle your upside expectations. And let the put options manage your downside expectations in price movement. This will keep things simple and keep you safer at the same time.
Day Trading Options – Tip #5: K.I.S.S. is for options too…
Iron Condors, Calendar Spreads, Straddles, Strangles…
It’s easy to get drawn into the excitement of the intriguing names. The seeming sophistication of exotic options combinations is attractive. Some of them make it seem like you can’t lose.
But an old piece of wisdom should applies here again…
“Keep It Simple Stupid.”
It’s a great philosophy, and it applies especially well to day trading options. Avoid the fancy stuff. Unless you are a seasoned options expert there is much working against you.
Issues with exotic order types include:
- Extra commissions
- Added execution risk
- Paying the spread on each option
And that’s only a partial list of the things working against complex positions.
Resist the temptation to over-complicate things. You want to get things done and be back in cash at the end of the day. Keep your options day trading simple for the best results.
Day Trading Options – Tip #6: Separate checks, please!
Traders can obscure their results when day trading options. And it may not be an intentional move. All it takes is a failure to separate options trading from other trading activity.
It’s easy to combine those options trades with other trading products, strategies. And it’s dangerous as well.
HERE’S AN EXAMPLE OF HOW IT CAN HAPPEN:
Think of a trader who has a $20,000 account. The decision to only day trade options with 10% of it means a $2,000 allocation. An end of day statement showing a $1,000 loss may look acceptable in the context of a $20,000 account. It’s only a 5% loss.
“Keep a separate account for your options trading to keep everything straight.”
Careful inspection reveals the entire $1,000 loss came from day trading options. The reality is a 50% loss for the strategy that is day trading options.
Prevent filtering options trading results with rose colored glasses. Create a separate account for day trading options. You’ll know exactly where you stand with a particular strategy.
Do this and keep options trading results – bad or good – from hiding within a larger account.
Day Trading Options – Tip #7: Avoid compounding
“Compound interest is the eighth wonder of the world.” ~ Albert Einstein
It’s true. This is also why lots of traders, including me, love trading. The ability to compound is great. But don’t do it when day trading options.
Getting wiped out and having to start all over in options trading is not unusual. In fact, it’s quite commonplace. At the same time, doubling your account size with options is well within the realm of possibility.
What you want to do is leverage the potential and preserve the profits in your options trading. Sweep the profits out of your options account often, instead of leaving them all to compound.
Trading with winnings, or “house money,” makes things easier on trader psychology. It’s the right thing to do in a high-risk environment.
And when you make the amount of your initial risk capital, take that out too as soon as you can. Trading options is great. Compounding is great. Don’t try to mix the two of them together, and you’ll be fine.
Day Trading Options – Tip #8: A tool of engagement
“The best traders look bored.”
This was one of the many pearls of wisdom from one of my trading mentors. I still get constant reminders of it.
It differentiates the serene calmness of a diligent pro who is deploying a time tested plan. Compare that to the quick money mentality of many new and struggling traders. It’s easy to see why the best traders often look bored.
“The best may look bored, but they are actually engaged.”
But I’ve learned that there’s also a risk to being too bored. Missing trades while sedated by the work you do every day is not a recipe for steady profits. And this lack of engagement is by no means a effective plan for life success.
Day trading options can be a great focusing tool that keeps you on your feet. Quick action and big moves will have you paying great attention to your trading screens. Don’t trade for the excitement alone, but make sure you stay engaged enough to be a sharp and active trader.
For more day trading techniques, tools & strategies, check out these articles:
- Key Considerations In Intraday Trading Success
- 4 Ways To Size Day Trading Accounts
- How Do Margin Trading Accounts Work?
Day trading options can be rewarding and challenging. Make sure that you incorporate these 8 tips for the best results.
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