Options For Day Trading
Updated: Jan 24, 2021
Hello everyone , hope you all are having a wonderful day ! In today's post we will be discussing some options basics and how we can options as a tool for day trading. Going over what greeks are the most important to us , and what we should be looking for in terms of stock selection.
When most people think of the stock market, the initial thought is always on shares and buying and selling shares for profits or losses. Many are unaware of what stock options are and how to use them. In today's post we will discuss the surface level of options, what they are, and how they work. (We will assume we are buyers in this situation only , and not short selling options).
For beginners a stock option contract is a contract that gives the buyer the right, but not the obligation to buy or sell 100 shares of that given stock at the given strike price.
There are two different options, a call option and a put option, and as stated above we will only be evaluating the buy to open side of options in this post, as that's our primary form of trading.
A Call Option is placed on a stock with the expectation that the stock will go up, Say stock X is at $100, and we are expecting stock X to move towards $110, we would buy a call option (we will discuss the different expirations and strikes later) .
Meanwhile a Put Option is placed on a stock with the expectation that the stock price will head down, so say stock X is at $100 and we are expecting a down move towards $90 , we can buy a put option to make profit off this down move.
You may be asking , "how does an option move ?" , well it moves in relation to the four common option greeks , Delta, Theta, Gamma and Vega. For the purpose of day trading , the two most important options to us are usually Delta and Theta, followed closely by Vega, and in some cases , where looking for quick in and out plays ... these greeks can be completely ignored (will discuss later down the page) .
DELTA - Delta is the greek that decides how much money we make or lose for every $1 move in the stock. Say stock X was at $100 and our delta was $50 and assume we had a call option. (For this example assume that none of the other greeks exists and this is the only indicator for stock option movement).Now if stock X moves down $1 , we will be down $50 and if stock X moves up, we will make $50. This greek is your best friend in seeing how much money a potential move can make, (disregarding IV of course)
THETA - Theta, also know as time decay, is the greek that decides how much money we lose for every one day the market is open, or the closer to expiration we get. Say we buy a option contract on 1/11 (Monday) and it expires on 1/15 (Friday), let's assume theta is $30. That means for every one day that passes by, the contract will decay by $30 (grows larger as we get closer to expiration). (For this example assume that none of the other greeks exists and this is the only indicator for stock option movement).Say we bought the option contract at open on Monday , and assume the stock didn't move at all all monday , and then opened at the same price on Tuesday, we would be down -$30. Now assume we didn't move again and opened at the same price on Wednesday, we would be down -$31 (theta grows the closer we get to expiration), or now a total of -$61. This greek is the one that will eat way at the contract regardless of movement, and it will continue to get larger, the closer we get to expiration.
VEGA- Now comes vega, or the volatility greek, and this greek is important when primarily playing high movement stocks. Vega is the price a stock contract moves for every 1% increase or decrease in the volatility of that stock. Say Vega is $10 , that means for every 1% increase in stock volatility the contract will increase by $10, and for every 1% decrease in volatility the contract will decrease by $10. Vega is important because for high movement stocks like TSLA, AMZN, SHOP, any big mover, the contract already accounts for large stock movement, so the price of the contract is higher. Say stock X and stock Y both trade at $50 and both have similar option contracts, but let's say stock Y has been trading in a $10 daily range, where as stock X trades with a $2 range, or in other words stock Y moves a lot more than stock X. To account for this increase movement, or increase volatility, option contracts for stock Y will be priced higher than stock X, because it's already "predicted" to move more and have more volatility.
CHOOSING EXPIRATIONS/STRIKES ?
Now that we got the greeks out of the way , we can dip our feet in contract expiration and knowing which strike and expiration to chose. In short there is no wrong answer on which contract and strike to chose, as long as it's within your risk tolerance, and since everyone has a different risk tolerance, what I say may not be the best for you, and what suits you best may not be best for the next person. For the most part I either play close expirations like 2-3 weeks out when i'm looking for a day trade ( so I don't get theta eating away if it takes time) , 2-4 weeks out when looking for a swing , and then same weeks when im doing LOTTO plays (where i risk the entire contract). For the majority i usually play 2 weeks out , buying a contract that's in the 250-500$ range ( of course that varies when playing larger stocks like TSLA, AMZN) , but that's usually my go to.
Now as day traders, we don't care to much about the greeks, other than just understanding their basics (which were explained above) and then needing to know which way a stock should move for us to profit, like if i'm in a call it needs to move up, and if i'm in a put it needs to move down, and the faster that move happens, the more likely I am to make more money.
For example, say stock X was trading at $100 and i bought a $105 call for next week , and as soon as i bought it stock X starts trending up and moves into 102 , I can then sell some for a profit. "But wait, stock X isn't at 105 , how did you make money?" Remember, all we need as day traders is for the stock to move in our direction ,within a reasonable time frame and that's enough to take a high probability trade for profits. the stock doesn't have to hit our strike price , and we don't have to wait till expiration , just like.a normal stock, we can get in and out of options as long s there is someone on the market buying them (so as long as it has volume). In a similar sense , says the stock traded against you, you can get out and sell for a loss, you don't have to wait until expiration.
With this information in mind, it's best to catch breakouts + trending plays for close expiration options , because sideways price action can have negative theta affect. Or you can go 2-3 weeks out , find a consolidation play with low iv and look to take a longer term break trade.
You have to respect your risk , even more so with options because the losses are magnified, just like the profits, so make sure you know what your doing , and be smart with it. Don't try to make max profits, try to make high probability plays.
I didn't go to mch into specific setups +strategies for this post , but if there's enough interest i could share a setup or two on a new post , just drop a comment down below !
Hopefully this covered the basics of stock options and how to utilize them for day trading , if you have any more questions PLEASE DROP THEM BELOW !!!