Day trading options is simply buying and selling options within the same trading day; which means all positions are closed before the market close for the trading day. You’re probably more familiar with day trading stocks. When stock is used as the financial instrument, day traders’ critical decisions are ‘when to buy’ and ‘how much’.‘When to buy’ is usually answered through the use of technical analysis combined with some news. Fundamental analysis is rarely used in day trading because they’re more useful in longer term trading.
‘How much to buy’ is answered through the concept of money management; which is a very important concept every trader must know.
Technical analysis and money management are not covered in this article. If you’re interested in learning more about technical analysis, check out Charles D. Kirkpatrick book Technical Analysis: The Complete Resource for Financial Market Technicians. For money management, I recommend Bennett McDowell’s Trader’s Money Management System; the book is more inclined towards stock/futures traders but can be modified for options as well.
In day trading with options, there are more decisions to be made: Should we use call or put? Which strike price should we use? Which expiration month should we pick? In this article, I will try to answer these questions by giving some general day trading options rules. If we’re bullish on certain stock, we can choose to buy call or sell put options.
Selling options tries to take advantage of time decay, and since in day trading we are opening and closing trades in several minutes to several hours, the time decay will be small if not negligible.In day trading options, we should generally buy option. One exception to this rule is if we are trying to exploit option price discrepancy which particularly happens on expiration day.
The main reason we use option instead of stock is because we want leverage. Other than that, we’d like the option to behave like stock. Hence, we are going to use ‘delta’ to select our strike price.Delta measures the change of option price with respect to underlying stock price. The delta of an option is always between -1.00 and 1.00.
A delta of 0.7 means that for each one dollar increase in the underlying stock, the option price will increase by seventy cents.
Day trading options strategies usually tries to profit from stock price movement. Hence, the general rule is to select strike price which has the absolute delta value as high as possible. My personal preference is to select strike price that has absolute delta value between 0.7 and 0.85. That means 0.7 to 0.85 for calls and -0.7 to -0.85 for puts. I would occasionally go with absolute delta of 0.65, but never below 0.6.
When buying options, the general rule is to never buy front month expiration (the closest option to expire). This is because option is a wasting asset; and front month options loses value faster than back month options. In day trading options, this rule can be applied more loosely. This is because in day trading options, we are in and out of our trading only in several minutes to several hours. Hence the time value decay will be very small.
My personal preference is to go with the front month if it has more than 20 days to expiration, otherwise I will go with the back month. One exception is when company is releasing its earnings report or on expiration day; be very careful on these days. To summarize, our general day trading options rules are:When bullish, buy call. When bearish, buy put. Do not sell call or put when day trading unless you want to exploit option price discrepancy on expiration day.
If you are, check out Jeff Augen’s book above. Select strike price of the option that has absolute delta value between 0.7 and 0.85. Do not go with less than 0.6 unless you know what you are doing. Note that some broker quote the delta value in hundreds; if that’s the case then find the delta between 70 and 85. Go with the front month if it has more than 20 days until expiration, otherwise go with the back month option. Be very careful on earnings day or expiration day.
One thing you need to consider is day trading will take up a lot of your time; you might spend hours in front of your computer screen staring at charts and indicators. If you don’t have the time to spend hours in front of your screen, then day trading options is probably not for you.