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Day trading options involves buying and selling the same options contract on the same day. It is a strategy that is based on making a quick turnaround, which usually cuts both the risk and the potential profits. Traders can benefit from leverage, but must change their strategy to take into account that the option itself has an expiration date, at which point it may lose all value. The nature of day trading also means traders should pay close attention to transaction costs.
One of the main differences between day trading options and simply day trading stocks is that it is possible to use leverage. With stocks, the investor needs to pay the full purchase price upon buying the stocks. With an option, the investor only needs to pay for the right to the option, which will be a much smaller cost. This means the investor can trade a large value of stocks, with the associated potential high returns, while only needing a relatively small amount of up-front cash.
Trading in options has another fundamental difference to stocks — that the option has the potential to instantly become worthless if it comes to expiration date and the relationship between the contract strike price and the current market price is against the investor's favor, meaning there is no point taking up the option. The closer it gets to the expiration date with the option looking likely to be unfavorable, the less demand there will be for the option and thus the lower the price of the option itself will become. This can potentially create a battle of nerves, with no trader wanting to be holding the option when it expires in an unbeneficial position. Day traders, therefore, need to be very careful to act rationally in such a position, rather than let emotions take over.
Another key to successfully day trading options is remembering that there are two separate sets factors affecting the demand and supply for the option, and thus its price. One is the price of the underlying asset and the factors that affect this price. The other is the ever-declining amount of time left until the option comes due. Usually, the time factor will act as an amplifier to the asset factor. The closer the expiration comes, the better a good position looks and the worse a bad position looks.
With day trading options, even more than traditional trading, it is vital to understand the transaction costs for the particular market, broker or online trading system being used. In situations where the trader must pay a fixed fee for every transaction, day trading can become much harder. This is because day trading usually involves a large number of transactions rather than holding assets for a long time.
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