You can buy a stock option on one day and close it the next day. In fact, you may buy or sell stock options as frequently as you choose. Day traders often hold options for mere hours or even minutes. Option prices can change rapidly, so a quick sale might make good sense. Short-term trading systems based on technical analysis might generate several trading signals in one day. The rub is commissions: Even using a discount broker, you’ll probably spend at least $4 to buy an option, and the same amount to sell it.
A stock option gives the buyer the right to purchase or sell 100 shares of the underlying stock at a specified price -- called the strike price -- on or before an expiration date. When you buy an option, you pay the price, called the premium, upfront. The options exchange quotes prices on a per-share basis. For example, an option priced at $2 will cost you $200 plus commission. Modern online brokerage accounts can execute a market order for an option in a few seconds.
You can buy an option to open or close a position. The same is true for selling an option. You place a market order when you want to purchase or sell the option immediately at the current price. If purchasing, you’ll shell out the lowest offer price; if selling, you’ll rake in the highest bid amount. If you place a limit order, you set a ceiling on the amount you’ll pay, or a floor underneath the amount you’ll accept; but you risk not completing the trade if the option price doesn't hit the limit amount. A stop order tells the trading system to close your option position under certain circumstances. For example, if you set a stop loss at $1.50 on an option you own, the system will enter a market order to sell if the option drops to $1.50 or less.
Closing an Option Position
You close an option position through an offsetting transaction. For example, if you tire of owing an option -- a long position -- you can enter an order to sell an identical option. The two options offset each other and cancel out. Similarly, if you create an option position through a sale -- a short position -- you kill the position by buying the identical option. If the option is exercised before you close your position, you must deliver or accept delivery of the underlying stock, depending on option and position type. The same is true for options that expire with value -- worthless options expire without the need for further action.
You might employ technical analysis to guide your option trading. Technical analysis looks at previous price and volume information in an attempt to predict future prices. You can choose from many systems of technical analysis, including trend following and trend reversal. Day traders frequently use technical analysis to make fast money on short trends. Option prices can undergo rapid percentage changes and might be well suited to a day trading strategy. Day traders usually close all of their positions before the final bell.
If you do rapid trading of options, your short-term capital gains and losses will mount quickly. The options exchange and your broker keep detailed records of all trades so that you can report each one on Internal Revenue Service Form 8949 and Schedule D. You subtract your capital losses from capital gains. Because these are all short-term, you pay taxes on your net gains at your marginal rate. If your losses exceed your gains, you can offset up to $3,000 of ordinary income in one year and carry any remaining capital losses forward to future years. If you repurchase or resell the same option within 30 days, the "wash-sale rule" prevents you from claiming any capital losses on the option. You cannot expense commissions -- add them to your purchase costs and subtract them from your sales proceeds.
- Options Industry Council: What Is an Option?
- Optiontradingpedia: Types of Option Orders
- Trading Concepts: Exiting an Option Position
- The Options Guide: Day Trading Using Options
- TradingSim: Understanding Options with Technical Analysis
- IRS Publication 550: Investment Income and Expenses (Including Capital Gains and Losses)
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.