Archive for the ‘Day Trading’ Category
Day trading is the type of trading in which security is bought and sold on the same day. In a way, they are similar to binary options. This is seen as an easy way of making money by many, although no one have become a millionaire through day trading. Although there is no reliable data about day trades, about 80% of money spent on day trades is assumed to be lost. Although day trading is mostly seen in stocks, day trading options are also common. Options are actually contracts that give the right to sell or buy an underlying asset at a strike price before an expiry date. While buying an option only a small premium is paid and not the full amount. As a result the maximum loss in an options trade is limited to the small premium paid. The options are also versatile financial instruments. The versatility and loss limiting capacity of the options makes them a safe choice for day trading among many day traders. But in reality they are not safe for day trading because of many factors. Day trading options won’t provide much profit to a person with less knowledge like day trading of stocks.
First thing that limits the profit of day trading options is the time value component of the option premium. So the movement in the price of an underlying stock in a single day won’t be reflected in their options. As the stock price goes up the rise in option is offset by the loss of time value. So it is not possible to day trade options by tracking their stock price.
Another thing that limits day trading profits in options is their lower liquidity. The options are not liquid even though their underlying stock is liquid. So the bid-ask spread of options are much higher than their underlying stocks. This reduces the profit potential of day trade of options.
The first requirement to make profits in day trading options is to remove the problem of lower liquidity. Selecting options of liquid stocks might be a solution but not a complete one. Although some stocks are highly liquid on some days due to factors like news this liquidity is not reflected on options.
The best solution to solve the low profitability of options is to select options that are approaching their expiry date. This is because the price of options nearing their expiration date is dependent on their intrinsic value and less dependent on their time value. Therefore the expiring options are considered to be more liquid than other options and are recommended for day trading.
Another way of day trading is to buy or sell options as a part of hedging or protecting existing investments. Protective put positions are a commonly used strategy for this. If you are expecting a price fall in the stocks you hold in a day you can buy put positions of the stock. This gives you the right to sell the stocks at a strike price even if the stock price falls down. This protective strategy is known as protective put position. If the price of stock goes high you only loss the premium paid.
Because of the factors that limits the profitability of the options, day trading of options is only recommended for those who have good knowledge and experience in the field of options. Knowledge of the underlying stock is very important for understanding the day trading prospects of a particular option. Otherwise the day trading of options would become a mere gambling. So it is better for inexperienced traders to stay away from day trading options.