Day Trading Options: The Complete Guide 2019
The excitement, the exhilaration. Profitable sessions never get boring. If you know what you’re doing, options can provide the same benefit as day trading stocks. Fasten your seat belts, this is another comprehensive post from our day trading for beginners series.
But keep in mind, predicting the direction of the underlying isn’t the only variable.
Delta. Gamma. Vega. Misinterpreting the ‘Greeks’ can wreak havoc your bankroll.
In this guide, we’ll tell you what you need to know about day trading options. Learn how to get started, understand the ‘Greeks,’ and the top strategies professionals use on a daily basis.
But there is more. We will cover the most profitable option income strategies and take a closer look at selling weekly put options for income with 4 crystal clear options trading strategies.
Finally, you find a step-by-step guide on how to read an option chain the right way to maximize efficiency and profitability.
Is options trading considered day trading?
In a word – yes. Before you suit up, make sure you understand the day trading options rules.
The pattern day trader rule is a regulatory requirement passed down by the US Financial Industry Regulatory Authority (FINRA).
It stipulates that any investor who “executes four or more day trades within five business days” given the trades represent “more than six percent” of total trades within the same time period, must do so in a margin account of at least $25,000.
The rule applies to both stocks and options.
What about a cash account?
No relief either.
The US Federal Reserve employs a freeriding prohibition mandating you can’t use ‘unsettled funds’ to engage in another transaction.
Trades officially settle within two business days.
When you day trade – whether in equities or options -- you buy and sell so quickly that previous transactions don’t have time to officially clear.
According to FINRA, this makes the strategy against the rule.
Bottom line: open a margin account and maintain a $25,000 minimum or use a pattern day trader workaround.
What are the ‘Greeks?’
Before you begin day trading options, make sure you understand the ‘Greeks.’ Financial variables, ‘Greeks’ are option factors that affect the option price within and outside of changes in the underlying.
First up is delta.
Delta is a first order effect and measures the linear change in the option price given small changes in the price of the underlying.
Call deltas range from 0 to +1 and put deltas range from 0 to –1. For example, if a call option has a delta of 0.70, it means a 1% change in the value of the underlying will result in a 0.70% change in the value of the option.
Next is Gamma. Gamma is a second order affect that attempts to quantify delta-error.
Since delta measures the linear change in the price of the option, gamma accounts for non-linear changes or large increases and decreases in the underlying.
Gamma is always positive and the larger the number, the less you can rely on delta. When you see a large gamma, be careful.
Vega is extremely important. It quantifies volatility priced into an option. Volatility is the most important variable in option pricing and the higher the volatility, the more expensive the option is.
Look at the implied volatility statistic on an options chain: the higher it is, the more you need the underlying to increase for your positon to turn a profit.
Theta represents an options time value. Until an option expires, there is always some dollar value left in it – even if it’s completely out-of-the-money.
Rho is an options sensitivity to interest rates. This is important because rising rates increase the value of call options and decrease the value of put options.
The reason is: call options are considered ‘waiting to make a purchase.’ When money is still in your account – and not currently invested in the underlying – you can earn interest on that capital until you decide to exercise the option.
Because of this, interest rates are always added over the holding period.
Day trading weekly SPY options
The SPDR S&P 500 ETF (SPY) is one of the most highly traded and liquid ETFs out there. Many professional option traders use the index to make speculative bets or hedge risky positions in their portfolio.
Because of its high liquidity, it makes a great underlying asset for day trading options.
Buy or sell weekly SPY call options
A simple strategy is to buy or sell weekly SPY call options. Beforehand, most options traders feel out the mood of the market and decide which direction offers the greatest risk-reward trade off.
If you believe the market is primed for a rally, owning call options is a great way to participate with very low risk.
On the other hand, if you’re pricing in bearish sentiment, selling weekly call options can earn you quick income over a short holding period.
The greatest upside of selling weekly call options – rather than longer-dated options – is the benefit of time value decay.
Above, I wrote about the importance of theta. For short-term options, theta is much higher, which means you earn a greater time value premium with short-term options compared to long-term options.
A second benefit is risk management. When selling weekly call options you can narrow your prediction down to a short interval.
Instead of being liable for weeks or months, the short-term contract expiration allows you to take profits without the long term risk.
Buy or sell weekly SPY put options
Put options are always popular.
They act as insurance for long portfolios and selling them can be a great way to add income to your account. The best part is puts are usually priced much higher than calls.
Because of the insurance characteristic, investors are willing to pay a premium for peace of mind. If you have a strong sense the market will rise over the week or even remain flat, selling weekly put options is a great way to turn a profit.
Trade SPY Volatility
Remember above, I wrote Vega (volatility) is the most important variable affecting option prices.
Well, if you believe the market is primed for turbulence, owning puts will pay off in two ways: the decrease in SPY’s price and the increase in volatility. Rising volatility results in the implied volatility statistic increasing on the options chain.
This will make future put option contracts more expensive and increase the value of your position along with it.
Options Day Trading Strategies - Fundamental and Technical
When day trading options, there are two perspective approaches: fundamental and technical.
Fundamental Options Trading Strategies
When trading information, you’re buying and selling options based on news of the day.
Economic data, interest rate rhetoric from the Federal Reserve, or just a Tweet.
If you follow the markets, you know a single piece of information can send equities spiraling in various directions.
It wasn’t that long ago the Dow erased an 800 point loss because Jerome Powell – Chairmen of the US Federal Reserve – issued a dovish statement regarding the direction of future interest rates.
When material information like this hits, volatility spikes as the market assesses the news. And for the third time, volatility is the most important variable affecting option prices.
If you can positon yourself on the right side of the wire, you won’t have any problem ending up on the right side of the trade.
Recommended read: Technical Analysis Explained
Technical Options Trading Strategies
Trading Put-Call Parity
Trading put-call parity is a strategy built around exploiting arbitrage. Arbitrage profits occur when you earn a riskless profit without having to use any of your own capital.
The formula looks like this:
Put price + the underlying price = call price + present value of the call options strike price
When this equality formula doesn’t hold, you have an arbitrage opportunity. Say for example, we take Apple’s (AAPL) stock.
If the current share price is $154, an at-the-money put option costs $5, an at-the-money call option costs $4 and the current yield a 10-year US Treasury is 3%, the math works out like this:
- 5 + 154 = 4 + [154/ (1.03) ^ (1/52)]
- 159 = 157.91
As you can see, equality doesn’t hold. As an astute options trader, you can earn an arbitrage profit by shorting the stock at $154, buying an at-the-money call option for $4 and selling an at-the-money put option for $5.
With the transaction, you earn $1 per share. As well, interest isn’t a factor because you can invest the short proceeds during your holding period.
Most importantly, you’re completely hedged. If the stock price increases, you can exercise the call and cover any losses from your short positon.
If the price of the stock decreases, that’s fine as well because -- while the at-the-money put you sold will be exercised – you shorted the stock so you profit from all price decreases.
For equality to hold and eliminate the arbitrage opportunity, the call price would need to be $5.09.
Arbitrage opportunities like this don’t last long. When they spot it, traders execute the same riskless transaction over-and-over until supply and demand resets the price of the options.
As a daily strategy though, the opportunity can be quite profitable. Similar to scalping with equity day traders, arbitrage profits are minimal, but over time can add up to meaningful gains.
Day Trading Options Summary
Done right, day trading options is not that challenging. Day trading options can become one of your core option income day trading strategies as a good alternative to our favorite stock day trading gap and go strategy.
Before you start out, make sure that you know how to read an option chain and consider selling put options for income instead of day trading options.
Furthermore you should consider using a paper trading account first and once you are ready to start, make sure to use a brokerage account with low options trading commissions.
Also, make sure to use the right tools like Trade Ideas A.I. Pro to scan for good option trading opportunities. To find out more about Trade Ideas A.I. Pro, check out our latest Trade Ideas Review.
Option Income Strategies
How to increase your cash flow
Options. Options. Everyone likes options. From what to wear to what to eat – choice is the spice of life.
In a financial context, it’s no different.
Options give you the right but not the obligation to engage in a transaction. Ultimately, the choice is yours.
The great thing about financial markets is there are plenty of profitable opportunities just looking to be exploited. And with the right option income strategies, you can do just that.
So sit back and let us show you how to increase your cash flow.
What is option income?
Option income is the premium you earn from selling option contracts. Similar to bond interest or an equity dividend, option income is compensation for taking on risk.
When you sell a call, you give the buyer the opportunity to participate in a rally, so the premium is your return for the service.
When you sell a put, you’re protecting the buyer from downside risk. Thus, the cash inflow is similar to insurance premiums.
Do you pay taxes on options?
Yes. Option profits are considered short-term capital gains. They are taxed as ordinary income at your marginal rate – similar to bond interest.
Any investment held for less than one year receives the same tax treatment.
What are the best option strategies for income?
Glad you asked.
From beginner to advanced, there are plenty of profitable income strategies available.
Well start with the most basic:
A covered call is a beginner option strategy where you earn income on a stock you already own. Owing the asset acts as a hedge, but you’re still exposed to downside risk.
How do you write a covered call?
It works like this:
Say you own 100 shares of Microsoft (MSFT) and the current share price is $105. To execute a covered call, you simply sell a weekly – or longer – call option contract on the position.
A weekly at-the-money contract – with a $105 strike price -- is currently priced at $1.55 per share. Since contracts sell in lots of 100, the transaction results in a cash inflow of $155.
The strategy is popular because outside of the underlying going to zero, there is very little risk.
Even if you suspect the stock is in trouble – since you own it – you can sell your shares and exit the positon.
- Covered Call Max Profit: $155
- Covered Call Max Loss: [(105 – 1.55) * 100] = $10,345
A covered put is similar to a covered call. The strategy involves shorting the underlying stock and selling put options.
Remember, when you short a stock, you profit from any downside movement. Since puts increase in value when the underlying declines as well -- having a short position ensures you’re hedged.
Unlike a covered call though, losses are unbounded. When a stock price falls it can only go to zero. However a stock can increase by 200%, 300% or even more.
While it’s unlikely to happen – especially for a mature company like Microsoft (MSFT) – the possibility still exists.
Weekly at-the-money put options for Microsoft (MSFT) sell for $1.56 per share. Executing the strategy results in a $156 cash inflow per contract sold.
- Covered Put Max Profit: $156
- Covered Put Max Loss: unbounded
Bear Call Spread
Now you get to mix things up.
A bear call spread is used if you think the underlying will decline. The strategy involves selling a call option with a lower strike price and buying a call option with a higher strike price.
The lower strike call is always more expense, so the transaction results in a cash inflow.
Using the Microsoft (MSFT) example, the strategy works like this:
A weekly-at-the-money call option - -with a strike price of $105 – is priced at $1.55 per share. An identical call option with a strike price of $108 is priced at 45 cents per share.
The net result is a cash inflow of $1.10 per share or $110 per contract.
The main advantage is less downside risk.
If the underlying increases, you’ll have to sell the stock at the lower strike price. However, since you also bought calls with a $108 strike – any increases above that are completely hedged.
- Bear Call Spread Max Profit: [(1.55 – 0.45) * 100] = $110
- Bear Call Spread Max Loss: [(108 – 105) - (1.55 – 0.45) * 100] = $190
As you see, the risk-reward trade-off is much greater.
Bull Put Spread
Similar to a bear call spread, you can use a bull put spread to generate income as well. The strategy involves selling puts with a higher strike price and buying puts with a lower strike price.
Again, the higher strike put is more expensive and results in a cash inflow.
Current Microsoft (MSFT) weekly at-the-money put options are selling for $1.56 per share. Put options with a $103 strike are selling for 77 cents per share.
The net result is a cash inflow of 79 cents per share or $79 per contract.
Again, risk-reduction is the greatest benefit. By owning the lower-strike put, you’re hedged for any decreases in Microsoft’s share price below $103.
- Bull Put Spread Max Profit: [(1.56 – 0.77) * 100] = 79$
- Bull Put Spread Max Loss: (105 – 103) – (1.56 – 0.77) * 100] = $121
A collar is clever way to hedge an existing position and generate option income at the same time.
The strategy involves owning the underlying, buying a put option and selling a call option. A collar acts as a hedge against both large increases and decreases in the stock price.
Take Microsoft (MSFT) again:
The current share price is $105. A weekly at-the-money call option sells for $1.55 per share while a similar put option sells for $1.56. Remember, both have a strike price of $105.
By selling the call and buying the put you’re completely hedged. The transaction also results in a cash inflow of 1 cent per share or $1 per contract.
- Collar Max Profit: [(1.56 – 1.55) * 100] = $1
- Collar Max Loss: 0
As you can see, a collar protects you in either direction. The downside though, is profits are minimal. The strategy is meant to mirror a risk-free investment, similar to owning a 10-year US Treasury.
To get around this, many collar-enthusiast decrease the put strike price to increase their cash flow. Remember, a $103 strike put is priced at 77 cents.
Positioning this collar results in a net inflow of 79 cents per share or $79 per contract.
However, there are two sides.
By lowering the strike price, you increase your downside risk. Any losses from $105 to $103 will not be hedged.
A short straddle is the highest income generating option strategy available. It’s also the most risky.
You play it by selling both a call and a put – of the same strike price -- without having a hedge in place.
Going back to the Microsoft (MSFT) example, weekly calls and puts are priced at $1.55 and $156 per share. If you sell both, you receive a total inflow of $3.11 per share or $311 per contract.
The income factor looks great, but the downside is significant. Naked calls are unbounded on the upside, so your losses can theoretically extend to infinity.
The put is bounded by zero so your maximum loss is Microsoft going bankrupt.
- Short Straddle Max Profit: [(1.55 + 1.56) * 100] = $311
- Short Straddle Call Max Loss: unbounded
- Short Straddle Put Max Loss: [105 – (1.55 + 1.56) * 100] = $10,189
Keep in mind, a short straddle is a highly speculative strategy. It should only be used if you have significant option experience or have other hedges in place.
A strangle is similar to a straddle, only here you’re mixing up the strike prices. The main benefit is more control over upside and downside risk.
For example, if you think Microsoft is more likely to rise than fall -- you can sell an at-the-money put for maximum income as well as increase the call strike price to $108 from $105.
Conversely, if you think Microsoft is more likely to fall than rise, you can sell an at-the-money call and decrease the put strike price to $103 from $105.
Again, both variations are highly speculative, so proceed with caution.
So what is the best option strategy for income?
Basically, you should stay away from options trading. The risk of losing all your money is significant. Trading stocks might allow you to make a mistake without ruining you.
However, one wrong decision trading options can cost you all your money, and you can also end up losing more money then you have.
If you have experiences trading options and you are aware of the risk, then the bear call spread, bull put spread or the collar strategy might fit with lower risks.
When breaking down the math, it’s easy to see all three generate solid income while at the same time protecting from catastrophic losses.
As well, the strategies allow you to tweak your strike prices so you can tailor your position to your own perceptions about the stock.
If you want to increase risk, plenty of options are available, but you should definitely stay away from such high risk options income strategies.
Selling Weekly Put Options for Income
4 Option Trading Strategies for your portfolio
When most people think of income investing, the first products that come to mind are certificates of deposit, Treasury bonds or real estate investment trusts (REITS).
Pretty boring huh?
Well, if you dabble in put options, it doesn’t have to be.
Selling weekly put options for income can offer plenty of benefits for your portfolio.
And best of all -- when done right --still allow you to maintain a low-to-moderate risk profile.
In this guide, we’ll walk you through our top-four strategies and show you how to start profiting today.
The first thing you need to know about options is how they generate income.
When you sell a put option, what happens?
First, you receive a cash inflow from the transaction. Option contracts are sold in lots of 100. What that means is: each contract is based on 100 shares of the underlying.
For example, a weekly at-the-money put option for Walmart (WMT) is priced at $1.19. When you sell one contract, you’ll receive an inflow of $119.
How much money do you need to sell a put option?
The great thing about selling weekly put options is you don’t need a large bankroll. The main issue is trading commissions.
Brokerages usually charge a higher commission for option contracts than tradition equity transactions. This eats away at your profit, so take that into account before you get started.
A second issue is initial and maintenance margin.
Selling weekly put options for income exposes you to future liabilities. If the share price of the underlying stock or index decreases, you’ll be liable to buy the shares back at the higher strike price.
Because of this, brokerages will insist you post collateral to cover any future losses. Since options mark-to-market each day, you’ll also be required to post additional maintenance margin if your position declines.
Different brokerages have different requirements, so discuss the issue beforehand. Recommended read: What is buying on margin
Selling weekly put options for income: 4 strategies
People new to option trading usually ask: when should you sell a put option?
Well, the ideal time is when you expect the market to rise or stay flat. Put options profit when the underlying decreases in price and can be used for swing trading strategies.
Since you’re selling the contract, you’re on the other side of the trade. When the underlying increases in price, you’re in the clear.
Selling naked puts
The term ‘naked’ means you sell put options without hedge in place. This is the most basic strategy available and you can generate monthly income by selling puts as long as the underlying doesn’t decrease.
When deciding if it’s the right time to pull the trigger, you need to assess the current market environment.
Volatility spikes are function of news hitting the wire: The US-China trade negotiations. Interest rate rhetoric from the Federal Reserve.
Macroeconomic data like jobs reports as well as PMI/CPI numbers.
Daily events like these lead to what professionals on Wall Street call, ‘repricing risk.’
Analysts and traders reset their models to adjust for new expectations on economic growth, interest rates and overall market sentiment.
This is your opportunity. Savvy traders who can gauge bullish or bearish sentiment and read through the tea-leaves of economic data have much better insight into where the market is headed.
It’s like predicting the weather. If you see sunshine ahead for the market, sell weekly put options for income. If clouds start to form, hold off for a better opportunity.
Bull put spread
A more advanced strategy is to incorporate spreads into your toolkit. A bull put spread is where you buy a put option at a lower strike price and sell a put option at a higher strike – both having the same expiration date.
The higher strike is always more expensive, so it results in a cash inflow.
It works like this:
A weekly at-the-money put option for Walmart (WMT) is priced at $1.19. The strike price is $95. The same weekly put option with a strike price of $93 is only 52 cents.
You can construct a bull put spread by selling the $95 strike for $1.19 and buying the $93 strike for 52 cents -- which results in a net-inflow of 67 cents per share or $67 per contract.
The logic here is risk reduction. If you sell a ‘naked’ put at $95 your maximum profit – per contract – is $119.
Your maximum loss though, is the underling going to zero, minus the profit from the put option contract: [(95-1.19) * 100] = $9,381.
Now obviously the result is a little skewed. It’s quite unlikely a stock goes to zero in one week – especially a well-run company like Walmart – but you get the point.
Now check out the numbers from a bull put spread perspective. Your profit and loss looks like this:
- Bull Put Spread Max Profit: [(1.19 – 0.52) * 100] = $67
- Bull Put Spread Max Loss: [(95 – 93) – (1.19 – 0.52) * 100] = $133
As you can see, the risk-reward trade-off is much better. By implementing the spread, you’re hedged for any price reductions below the $93 mark.
You give up 52 cents in max profit but I’m sure you can agree, the reduction in maximum loss is more than worth it.
Bull calendar put spread
A bull calendar put spread is similar, but uses a slight tweak. Here, you buy and sell put options with the same strike price but mix up the expiration dates.
The strategy looks like this:
Buy the weekly at-the-money put option for Walmart (WMT) with a strike price of $95, priced at $1.19.
Then sell a two-week at-the-money put option with a strike price of $95 for $1.56. The net result is a cash inflow of 37 cents per share or $37 per contract.
Similar to a naked put though, you’re completely exposed on the downside. If the underlying goes to zero, you’ll be in for a loss of $9,463.
However, the reason this is such a popular strategy is because it allows you to trade time.
If you expect volatility to spike sooner rather than later, you can positon a bull calendar put spread, be fully hedged for the first week and earn income in the process.
The downside – of course – is the second week the hedge is gone.
If you’re just starting out, our advice is to stick with the lowest risk options trading strategy. Save the calendar spreads for when you have more experience.
A short straddle is also very risky so proceed with caution. Unlike the other three strategies, here you implement call options into the trade.
The main benefit of a straddle is it offers the highest income generation possible.
The strategy is to sell both a call option and put option with the same strike price.
From the Walmart example, it means selling the $95 strike weekly at-the-money put option for $1.19 and selling the $95 strike call option for $1.06.
- Short Straddle Max Profit: [(1.19 + 1.06) * 100] = $225
As you can see, the income potential is there.
A straddle is best used when the market trades flat. Since you’re exposed on both the upside and the downside -- a large spike in either direction will cost you dearly.
When analyzing your maximum loss, the numbers are scary. From a call perspective, the loss is unbounded.
The underlying can increase to infinity which means you’re liable for any gains. From a put perspective, the underlying can only go to zero.
- Call Max Loss: unbounded
- Put Max Loss: [(95 – 1.19) * 100] = $9,381.
As with a bull calendar put spread, short straddles are best used when you’re comfortable predicting the mood of the market.
The exposure is immense, so if you’re just starting out, stick with the safer bull put spread.
If you’re keen on using the strategies above, there are ways to hedge your exposure so you gain the same risk-reward trade-off as the bull put spread without the downside of a naked position.
Inverse Index ETFs
When hedging a put position, you need an offsetting short position. The problem is, shorting requires a margin account, a stock loan fee and interest charges.
A more cost-effective approach is to use an inverse index ETF. You can use the ProShares Short S&P 500 ETF which is a great proxy for the US equity market.
When you feel the mood music starting to change and you want to hedge your put positon, you can buy shares of the inverse ETF.
For example, if you have $2,000 put position, you can buy $1,000 worth of the ETF and roughly cut your exposure in half.
It’s important to note though, indexes and options aren’t directly correlated so the two will not reprice exactly alike.
However – when accounting for costs -- using an index to hedge is your best bet.
Conclusion about selling weekly put options for income
Options are high risk. While day trading stocks is more challenging than long term investing, day trading options is even more risky.
Make sure that you understand what you are doing here! Always start out with a demo account or trade simulation. Never risk you money right away.
How To Read An Option Chain: A Step-By-Step Guide
Many investors want to trade options but don’t know where to start. Unlike equities, it takes a bit of research to understand how option trades work.
Strike price. Open interest. The terminology can be confusing.
I mean, what’s implied volatility anyway?
Well, don’t worry because we’ve got you covered. In this guide we’ll show you everything you need to know about how to read an option chain.
We’ll breakdown all the little details so you have the confidence you need to make your first trade.
What is an option chain?
An option chain provides a list of various data -- tallying prices, expiration dates and selling activity for call and put options of a given stock.
The data is displayed in real-time, which gives you a window into how the market is behaving and what is required to complete a particular trade.
So what is the best option chain website?
We recommend Nasdaq.com. It’s a reputable service and one of the largest stock exchanges, providing real-time updates and plenty of other useful market information as well, or alternatively the option chain provided within your brokerage account.
How to read an option chain
When breaking down an option chain, a visual aid always helps. Take a look at the image below. It’s the most recent option chain for Nike (NKE).
So how do you read option symbols?
Well, let’s start from the left and work our way right.
At the top of the picture you can see the months Jan 19, Feb 19, March 19 etc. These represent the expiration dates for various call and put options.
Calls are in the left column and puts are in the right column. When you click on a particular month, you find all the necessary data about contracts expiring within that time frame.
So how does option expiration work?
Think of it like a carton of milk. An options expiration is similar a milk’s best before date. If you don’t exercise your position by the expiration date, it’s worthless.
And like sour milk – you simply throw it away.
The ‘last’ figure describes the last price an option sold for. Check out the second row with the 7.47 figure. This means the most recent March 08, 2019 call option contract sold for $7.47.
What is net change in an option chain?
Well, take a look at the right side of the image. Under the Chg. figure, you’ll notice there is a –0.34 five rows from the top.
This tells you the change in the option price from the most recent contract compared to the one before it.
For example, the last price for a March 08, 2019 put option is 50 cents. That represents a 34 cent decline from the contract prior.
Doing the math, you can infer that the previous contract sold for 84 cents.
Bid-ask quotes are like a supply and demand tug of war. Buyers – who set the bid – want to buy options at the cheapest possible price.
Sellers – who set the ask – want to receive the highest possible price; so they ‘ask’ buyers for more money.
The main takeaway is the bid is always less than the ask. The logic is the same as bid-ask quotes you see for traditional stocks.
One caveat – like we discussed above – is the last price. If you notice, the 7.47, 5.10 and 4.23 are all less than the bid and ask prices.
The reason is: the number of contracts sold for these options are very low so there isn’t enough activity to support the current bids.
The contracts that did sell -- 7.47, 5.10 and 4.23 – were agreed upon many days ago and the supply and demand dynamics have changed since then.
Volume is extremely important. Like a stock – it determines the level of liquidity in a financial instrument.
With options, volume measures the number of contracts exchanged within that day for a given expiration date.
For example, one contract sold per-day contributes 1-unit of volume to the statistic.
Looking at the chain, you’ll notice volume is 0 for all of the call options and no more than 1 for all of the put options.
The takeaway is: no option contracts have been exchanged on that given day. Like I described above regarding the bid-ask, the 7.47, 5.10 and 4.23 contracts were finalized many days ago.
If volume is Batman, then open interest is Robin.
Open interest tells you the amount of option contracts that have yet to be exercised. American options – unlike European – can be exercised at any time.
However, because option prices have embedded time value, traders avoid exercising early. Doing so is like giving away free money.
It’s better to sell the option contract to another trader to ensure you receive full value.
Check out the chain again.
For the contracts I mentioned, you see open interest of 5, 4 and 2. With this information, you know 5, 4 and 2 contracts are still open and available for trade.
The root tells you the ticker symbol of the underlying asset. We’re using the example of Nike (NKE) and as you see -- the chain root is NKE. Some option providers use different name variations but it’s not hard to figure out.
Now we’ll get into the important details.
When you buy an option contract, you specify the desired strike price.
For a call option, the strike price represents the price at which you can buy the underlying stock, should you decide to exercise the option.
For a put option, it represents the price at which you can sell the underlying stock, should you decide to exercise the option.
Keep in mind, we’re describing this from a buyer’s perspective.
The strike price is one of the most important factors because it determines the premium you pay for the option.
When an option is in-the-money, you pay more, when it’s out-of-the-money, you pay less.
In-The-Money (ITM) and Out-Of-The-Money (OTM) Options
Analyze the new section of the Nike (NKE) option chain. The shaded areas on the left represent in-the-money call options and the shaded areas on the right represent in-the-money put options.
ITM options have what traders call ‘exercise value.’ This represents a sum of money already priced into the option premium. Nike’s (NKE) stock is trading at roughly $81.25, so we’ll use the 81-strike call option to explain.
If you bought an 81-strike call right now and exercised it, you would make a profit of 25 cents per share. Because of this, option sellers add 25 cents to the cost of the option.
The rest of the option premium -- $2.28 minus 25 cents – represents the cost of time value and implied volatility.
Implied Volatility (IV)
Now the most important point.
Implied volatility (IV) is the single most important factor determining option prices. IV is financial jargon for the statistical term standard deviation (SD).
When trader’s price options, they assess how likely a stock is to jump above the strike price for a call option or fall below the strike price for a put option.
Using a normal distribution bell curve, a 1-SD move infers a 68% probability, a 2-SD move infers a 95% probability and a 3-SD move infers a 99% probability – assuming a historical sample repeats itself.
Now, from a seller’s perspective, dealers and traders use these probabilities to decide how much they’re going to charge you for the option.
Let’s look at the ‘Greek’ Statistics from Nike’s (NKE) option chain:
Pay attention to the numbers in the sixth column from the right. The other figures represent delta, gamma, rho and theta.
These are just as important but we cover them in other articles. For now though, look at the 0.09152 number next to the 81.5 strike price.
The figure implies the market is pricing – with a 68% probability – a 9.152% annual change in the price of Nike’s (NKE) stock.
Given the stock is trading at roughly $81.25 right now, you need to believe the end-of-year stock price is going to range somewhere in between $73.81 to $88.69 to justify buying the option.
- [81.25 * (1 – 0.09152)] = $73.81
- [81.25 * 1.09152) = $88.69
Since the options have roughly a two-month expiration, the two-month implied volatility (IV) of the option is [0.09152 * ] = 3.74%.
Thus, the market is assuming that within two months, Nike (NKE) has the potential to reach a price target of $84.29.
The current asking price for a two-month call option is $2.24. This requires a 2.76% increase in the current share price for you to breakeven.
Since the option price as a percentage of the share price is less than implied volatility -- it signals the options may be undervalued and could provide a decent addition to your portfolio.
How to read an option chain: Summary
It is crucial to understand how you have to read an option chain. As an option trader it will become one of your main tools and chances are that you will place your orders right from the option chain.
You should never start trading options without paper trading. Remember that!
Day Trading Options Summary
Yes, you made it! Day trading options for beginners was yesterday. Now, ~6,500 words later you learned the essential basics about day trading options.
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Make sure to read the Trade Ideas Review, once you are ready for the future of day trading.
Also, please take your time and re-read the article on your discretion and please, do never start day trading options with a live trading account! Seriously! Just never do that.
Once you believe, that you understood the basics, then make sure to start day trading options with a risk-free paper trading account. Furthermore make sure, that your free paper trading account provides an options chain and real-time prices.
Could, would, should will never be of help at all. This is why it’s crucial, that you put yourself in a position as trading with real money, even as a paper trader.
As always, in the end, it’s still up to you to decide, when you are ready to take action. However, with day trading options you have to be even more carefully.
Because day trading stocks might hurt you because you can lose all your money in your account. But day trading options can cost you much more.
I know, it sounds so easy. Your broker tells you that you only need a few bucks and you are ready to go. But rethink again and do the math first.
I hope this guide is helpful for you and it would be great if you share it with your friends.