There are many different asset classes that beginning day traders can become proficient in to maximize their profits. Options trading requires patience, risk tolerance, and an understanding of securities contracts in order to be successful. If you are looking to build an account from a hobby into a serious avenue for income and wealth creation, options are a great way to gain leverage. We’ve created a day trading options for beginners guide and how to best protect your funds from the volatility that inherently comes with it. While there is always risk involved in any sort of trade, the more knowledge and technical expertise you come prepared with, the more likely you are to profit.
Types of Options
By definition, an option is a contract that gives you the right but not the obligation to buy or sell a security (stocks, ETFs, or even indices) with a specific price and date. If you are looking to buy shares at a later date, it would be called a ‘call’ option, whereas selling shares at the date would be a ‘put’ option. In simpler terms, calls are for when you believe, an asset will go up in price, and a put is used when you believe the value will go down.
However, options are not the same thing as purchasing shares of stock. There are different values assigned to the contract based on the distance from the expiration date, and the investor can exercise the contract at any time. The contract price is based on the likelihood that the option will hit the ‘strike price’ (the agreed upon amount), and it is essentially a percentage value of the asset.
Of note, certain brokers require different margin requirements for accounts to trade certain options. If you are looking into naked puts, covered calls, and other complex strategies, make sure to check how your margin will affect your risk. Most of all, try to learn strategies slowly and without putting too much of your capital on the line so you can develop a business strategy that works for you.
Can You Day Trade Options?
A day trade is technically when you buy and sell the same security on the same day. This applies to stocks, bonds, and even options. It’s not a question of can you day trade options. It’s more a question of is day trading options profitable for you and your strategy?
In order to purchase options contracts for a short term window, the premium (or IV) will be much higher. This means that you need to have more certainty or be willing to take on more risk to the downside if your security is close to the strike price. Inversely, if the option is far away from the strike price, there is a lot of upside to be had, though the chances are slimmer. This is where having a comprehensive knowledge of the stock and its future catalysts, how the chart looks, and anything else that could let it get into the money will help you.
One of the most important elements of day trading – whether it is options, stocks, or any other security – is sticking to your trade plan. Options have the ability to create immense profits, but also immense losses. You should go into a contract with a price goal in mind and try not to deviate from it unless the information surrounding the option changes drastically. It is far too common to see beginning traders squander profits by going for unlikely highs only to see them turn into losses.
How to Trade Options
Whether you are looking for put or call options in the short term or buying leaps (which are options that have very far expiration dates), you should always be aware of the components to a purchase.
Typically, an option contract represents 100 shares of the underlying asset you are trying to buy (call) or sell (put) at a later date. This means when you buy one contract, you have the option to exercise it for those 100 shares. However, a common choice is to sell at whatever percentage increase is on the premium before the expiry date – as you trade more and learn your specific options strategy, you might find this to be more beneficial.
An example of how you would purchase a call option would be if you think there is going to be significant growth in a certain company and want to speculate on its price in three weeks. You are putting down what amounts to a non-refundable deposit should that company’s stock not rise in price to outpace the premium. This depends on the price of the stock and its future strike price, but for now we’re going to focus on the mechanics rather than the specific math.
We do want to make it clear that there are intricate variables (commonly referred to as Greeks) that play into how these contracts are priced and how their values can fluctuate for better or worse. These mathematical principles are easily learnable, and you need to know them for your options trading career. However, before you sprint to the literal calculus, you need to know what you are trying to accomplish.
Thus, research what your brokerage offers in terms of options for calls, puts, leaps, and any other type of contract you can purchase. See how the date affects the premium, and how the volatility or market conditions might affect the sentiment of a price. From there, it’s about researching the specific option and seeing whether it fits your trading plan.
The Ultimate Trading Plan
At StockAbility™, we pride ourselves on teaching people how to achieve financial freedom via trading as a business. There are many different ways to achieve this, and options trading can be very profitable if you take the time to learn from the pros.
We always emphasize that your approach and mindset will be the defining factor of your success. With our team of coaches and suite of resources, we will educate you and give you the confidence you need to trade for a brighter financial future. Sign up today to see what options we might have for you.