With options offering leverage and loss-limiting capabilities, it would seems like day trading options would be a great idea. In reality, however, the day trading option strategy faces a couple of problems.
Firstly, the time value component of the option premium tends to dampen any price movement. For near-the-money options, while the intrinsic value may go up along with the underlying stock price, this gain is offset to a certain degree by the loss of time value.
Secondly, due to the reduced liquidity of the options market, the bid-ask spreads are usually wider than for stocks, sometimes up to half a point, again cutting into the limited profit of the typical daytrade.
So if you are planning to day trade options, you must overcome this two problems.
For daytrading purposes, we want to use options with as little time value as possible and with delta as close to 1.0 as we can get. So if you are going to daytrade options, then you should daytrade the near month in-the-money options of highly liquid stocks.
We daytrade with near-month in-the-money options because in-the-money options have the least amount of time value and have the greatest delta, compared to at-the-money or out-of-the-money options.
Furthermore, as we get closer to expiration, the option premium is increasingly based on the intrinsic value, and so the underlying price changes will have a greater impact, bringing you closer to realising point-for-point movements of the underlying stock. Near month options are also more heavily traded than longer term options, hence they are also more liquid.
The more popular and more liquid the underlying stock, the smaller the bid-ask spread for the corresponding options market.
When properly executed, daytrading using options allow you to invest with less capital than if you actually bought the stock, and in the event of a catastrophic collapse of the underlying stock price, your loss is limited to only the premium paid.
If you are planning to daytrade a particular stock for short upside moves for the next few months, you can purchase protective put options to insure against a devastating stock crash.
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