Day trading options strategies represent, perhaps, the riskiest (and yet, most tempting) operations for traders eyeing quick profits. By exploring option day trading strategies and understanding how to day trade options, there is a lot to learn. Follow our guide, be ready to trade only an amount you are confident losing entirely and try to stick to your trading plan day after day. Can you day trade options? You can, let’s find out how.
Key takeaways
- Day trading options strategies involve buying and selling options contracts within a single day, with the goal of making quick profits.
- Due to their capped risk and potentially high reward, long calls and long puts are two great day trading options strategies.
- After the first hour of trading, you can buy calls or puts on SPY based on the trend observed and aim to secure profits by setting a sell order for a 10% gain.
Things to Know Before Choosing Day Trading Options Strategies
Before we get into more practical aspects, it’s essential to understand the basics of day trading options strategies. Options trading involves buying and selling contracts that give you the right, but not the obligation, to buy or sell an asset at a predetermined price.
Creating a solid trading plan is crucial. It helps you define clear entry and exit points, and manage your capital effectively. Trading options daily becomes more structured when you set specific goals and rules.
Technical analysis is a key tool for spotting trading opportunities. By examining charts and indicators, you can identify trends that inform your decision-making process. This insight is valuable for formulating option day trading strategies.
Risk management is another critical component. Setting stop-loss orders can protect your investment by automatically selling your position when it reaches a predetermined level. This minimizes losses and helps manage the risks associated with day trading options.
Lastly, keeping a trading journal is beneficial. It allows you to review past trades, understand what worked, and identify areas for improvement. Regularly updating your journal enhances your ability to day trade options effectively and refine your strategies over time.
How Does Day Trading Work in the Options Market?
Day trading options mean buying and selling options contracts within the same trading day. The goal is simple: make quick profits from small price movements. But before you jump in, there are a few basic principles you need to understand to manage your risk and increase your chances of success.
First, liquidity is critical. You want to trade options that are easy to buy and sell. Stick to highly traded assets like SPY, QQQ, NVDA, or similar liquid assets. These assets offer tighter spreads and make entering and exiting your trades easier. Also, these ETFs have options that expire daily, giving you great flexibility when trading.
Next, it’s essential to have a clear trading plan. This means knowing your entry and exit points before you make a trade. Without a plan, emotions can take over, leading to impulsive decisions. A good rule is to always set stop-loss orders to minimize losses and profit targets to lock in gains without constantly monitoring the market.
Here are a few simple rules to follow:
- Avoid the first hour of trading: The market tends to be volatile and unpredictable right at the open. Wait until at least 10:30 AM to see the direction of the market.
- Trade with the trend: Buy calls if the market is trending up. If it’s trending down, buy puts. Don’t fight the trend.
- Risk-to-reward ratio: Aim for trades where your potential reward is higher than your risk. For example, risking 1% to gain 2-3% helps stack the odds in your favor.
- Keep a trade log: As we mentioned in the previous section, you should consider writing down every trade you make. This will help you learn from mistakes and refine your strategy over time.
Day trading options can be fast-paced and exciting, but it’s not without risks. Make sure you’re only trading with money you’re prepared to lose, and remember that even the best traders sometimes lose. The key is sticking to your plan and managing risk effectively. If you panic because you think you are losing too much during a trade, it probably means investing more than you can afford to lose.
Long Calls and Long Puts as Day Trading Options Strategies
Long calls and long puts are excellent day trading options strategies because they offer capped risk and potentially high rewards. These day trading options strategies allow traders to capitalize on market movements with controlled exposure.
Specifically, this is what the P&L of a long call strategy will look like:
Notice the capped losses on the left, with the unlimited profit potential on the right. The specular situation will occur with a long put strategy:
You will go for these strategies when day trading, for a very simple reasons:
- On a bad day, you may lose at most 100% of your capital
- On a good day, you may earn more than 100% of your capital
This means that you won’t need to be always right to earn some money out of this day trading options strategy. In fact, mathematically, any success rate above 50% will end up giving you a long-term profit.
Following the Trend – How to Day Trade Options on SPY
Here is a day trading options strategy you may want to try out for day trading options on SPY, which involves following the trend to make informed trading decisions:
- Timing Your Trades: Avoid trading before 10:30 AM. The market is typically too volatile before this time, which can lead to unpredictable movements.
- Analyzing the Trend: Observe the trend during the first hour of trading. Based on this trend, decide whether to buy calls or puts. For instance, if the market shows a downward trend, consider buying puts.
- Choosing the Right Options: Buy SPY options that are 2-4 steps out of the money (OTM). Ensure that the options are not due to expire the same day (0DTE), allowing flexibility to close your position the next morning if needed.
- Setting Sell Orders: Immediately place a sell order targeting a 10% gain. This allows you to lock in profits without constantly monitoring the market. However, you may want to be flexible on this 10% target, as we’ll explain below.
- Closing Positions: Wait for your sell order to be filled, or, if your target isn’t achieved, close your position at the market open the following day.
We have backtested this trading idea for 2023. As you can see below, the profit of this strategy was really good throughout the first half of the year. However, the second part of the year was really disappointing:
Note that the y-axis indicates the USD profit or loss, while the x-axis contains the trading days in 2023.
As we told you above, the 10% target price should not be fixed, and you should develop sufficient experience looking at how SPY moves on an average day to understand that, on some days, you could easily target for 20-30-40% or even more.
The idea is: when you understand that you are in the right market direction, you should not rush to collect profits. These profits can come in handy during a bad day. Regardless: the foundation of this strategy is solid, you just need to add flexibility to this approach to improve it.
A Real Life Example on Buying SPY Puts
Imagine it’s 10:30 AM and SPY is priced at $558.30. You notice a clear downward trend in the first trading hour. Let’s assume it’s Thursday, and you decide to purchase a $555 put expiring the next day. This is what your P&L looks like, as taken from our options screener:
To break even by expiration, SPY needs to drop below $552.73. However, this isn’t crucial as your main goal is to see the put increase by 10% before closing the trade. If things go wrong, plan to sell your put at the opening price the following day.
This approach to day trading options strategies can help you capitalize on market trends while managing risks effectively. Note that it’s a high-risk strategy, as there is no guarantee that SPY won’t revert its trend right when you enter your position. It is certainly a good idea to try paper trading this strategy on your own before you put real money in it.
Notice that, for the sake of this example, we relied on index options. This is not done by chance: as we told you earlier, we’d normally stick to those options that have higher liquidity for day trading.
Risks and Benefits of Day Trading Options
At this point, we are ready to explore the risks and benefits associated with day trading options strategies. High market volatility can lead to significant losses, especially if trades are not carefully managed. This is a critical risk when engaging in option day trading strategies. On the flip side, the benefits include high liquidity and the potential for quick profits, making trading options daily an attractive proposition for many traders.
To mitigate these risks, consider the following strategies:
- Diversify Your Trades: Spread your investments across various options to reduce the impact of a single loss.
- Use Stop-Loss Orders: These can help limit losses by automatically selling an option when it reaches a certain price point.
- Set Realistic Profit Targets: Avoid greed by setting achievable goals for each trade.
Understanding how to day trade options effectively involves recognizing these risks and benefits, and implementing strategies to safeguard your investments. While you can day trade options profitably, you will need discipline, knowledge, and careful planning to have a decent profit over time. If this does not sound like a good match for you, consider longer-term strategies instead.
And also, you may want to exclusively rely on those strategies with uncapped profits for day trading. This is because you may find that going for capped profit trades (like a spread option strategy) may just not be worth the high-intensity activity that is day trading.
