Day Trading using Options

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Dividend Capture Strategy Using Options

Traders who use a dividend capture strategy usually trade in and out of a stock to obtain the stock’s dividend without having to hold it long-term.

Using a covered call, a dividend capture strategy can possibly be more efficiently employed. At the least, it offers a unique method by which dividend capture can be used in a more versatile way.

First, some terminology:

Declaration date

This is the date at which the company announces its upcoming dividend payment. Most companies pay dividends quarterly. Some pay monthly.

For example, a company could communicate that it will issue a dividend of $1.00 per share on said date.

Ex-dividend date

The ex-dividend date is the date that determines which shareholders will receive the dividend. To receive the dividend, you should be in the stock at least by the evening of the day before the ex-dividend date.

The ex-dividend date is often called the ex-date.

Record date

The record date is the date at which a company will look at its list of shareholders and determine who will get the dividend. Only shareholders who are registered on the company’s books as of the record date will receive it.

The record date is often set two days after the ex-dividend date.

Payment date

The payment date, also called the pay date or payable date, is when shareholders actually receive the dividend. It is usually within 30 days of the ex-dividend date, and normally no less than 5 days.

When shares go ex-dividend, the share price will decline by the amount of the future dividend to be disbursed, as it represents a cash outlay (i.e., a decrease in the company’s assets, thus lowering its equity value).

Most brokers, to avoid swings in portfolio value caused by the ex-dividend related drop, will credit accounts with a “dividend payable” between the ex-dividend date and the payment date.

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Example dividend distribution timeline

An example timeline of this process could go as follows:

  • Declaration date: March 6
  • Ex-dividend date: March 13
  • Record date: March 15
  • Payment date: March 31

Traders using a dividend capture strategy will want to buy in before the ex-dividend date.

However, because of the equivalent decline in the share price on the ex-dividend date, you may not necessarily “miss out”. Because shares decline by the dividend amount, holding all else equal, if you buy on or very shortly after the ex-dividend date, you may actually obtain a discount when the share price drops. Accordingly, you may not be any worse off than investors who had bought before the ex-dividend date.

Dividend Capture Strategy Using Options

Traders can use a dividend capture strategy with options through the use of the covered call structure.

A covered call is a strategy by which you buy the underlying security while selling an equivalent amount of call options to “cover” the position. When you sell a call option, you receive the premium. This has the function of capping your upside on the stock.

Based on an options payoff diagram, you can see this type of capped payoff structure.

There are 100 shares of a stock per each options contract. This means that if you owned 1,000 shares of a certain stock and wanted to form a covered call, you’d need to short (or sell) 10 options contracts on that security.

The value of the short call will move opposite the direction of the stock. Accordingly, this is inherently a type of hedged structure.

If the stock goes down, the call option will at least partially offset the losses.

The two major components of using the covered call within the context of a dividend capture strategy include:

(i) The strike price of the option

(ii) The days to expiration (DTE) of the option

To a lesser extent, there’s the consideration of when to put the position on relative to the ex-dividend date.

Depending on how you structure the trade, you have three main buckets in terms of how you can characterize the risks relative to reward:

(i) Low risk: Options are too deep in the money (ITM), which comes with the drawback of early assignment, covered in more detail in a portion of this article.

(ii) High risk: Options are too far out of the money (OTM), and don’t provide enough hedge value.

(iii) Moderate risk: At the money (ATM) options (or thereabouts), which gives you a quality hedge, but lowers early assignment risk.

We’ll go through each individually.

Covered call dividend capture strategy risk profiles

(i) Low risk

Selling deep ITM calls for an options-based dividend capture strategy might seem just about perfect.

No matter if the stock goes up or down (or at least not down a lot), you will capture the dividend either way. The hedge value is the highest and your risk is low.

However, the more ITM your call is, the greater the early assignment risk.

That means on the day before the ex-dividend date, an option with a dividend value that’s higher than the extrinsic value of the option (i.e., the value of the time premium plus implied volatility) is likely to be assigned.

That’ll call away your stock and you won’t get the dividend. The owners of the option – i.e., the party on the other side of the trade – is probably not going to passively allow you to collect the dividend that easily. That’ll close out the position.

When early assignment occurs, your return on the trade is effectively reduced to the premium of the option when you opened the position minus the price you paid for the stock.

For example, if you bought a stock for $100 and simultaneously sold call options on the stock at a 100 strike price, if you’re assigned early, your return would be equal to the option’s premium.

If you had bought the stock for $101 and sold calls at a 100 strike for a $3 premium, your net return is the options premium minus $1 per share – i.e., $3 premium from the option minus the $1 the shares were in the money, for a $2 per share profit.

If you had purchased the stock for $99 and sold calls at a 100 strike for a $3 premium, your net return would be the options premium plus your realized gain on the shares, which would be $4 per share – i.e., $3 premium from the option plus the $1 realized gain per share.

Some inexperienced traders try to use this low risk, deep ITM dividend capture strategy only to find out about the early assignment issue that derails their plans.

Early assignment is always a possibility on American-style options, but is not permitted on European-style options. If you are trading US stocks and options on them, you can be pretty sure you are dealing with American-style options, which bear early assignment risk.

Not all deep ITM options will be exercised. But as a general rule of thumb, if the extrinsic value of an option is lower than the dividend, the party on the other side of the trade will be motivated to exercise their option early to capture it.

Example

Let’s say you own a stock trading for $105 that’s covered with 100 calls. The intrinsic value of the option will be $5 per share – the $105 minus the 100 strike price.

Let’s say the annual dividend is $4 per share, or $1 per quarter. The option expires sometime after the ex-dividend date, so this is the only dividend compensation that will come up over this option’s remaining maturity.

If the option is priced at $5.50 per share, is the option owner likely to exercise early assignment?

Most likely they will.

We know the intrinsic value of the option is $5. That means the extrinsic value of the option is the difference between its price ($5.50) and the $5 intrinsic value, or $0.50.

The quarterly dividend distribution is $1, which is higher than the $0.50 extrinsic value. So, yes, the owner is most likely going to be choosing early assignment. It is not a guarantee, but it is likely.

(ii) High risk

If you place your call options too far OTM, you will lower the risk of early assignment. But they will lack much in the way of hedge value and you won’t materially lower your downside protection.

Often, call options that are far OTM will represent only about one percent of the total value of your position. In other words, if it falls 20 percent, which is natural for a stock, it doesn’t provide much in the way of reducing your downside.

For example, let’s say Apple (AAPL) is $300 per share. 400 strike calls out one year are about $4 per share. That means the value of your hedge when going 33 percent OTM (400 strike price divided $300 share price) is only just over one percent ($4 per-share premium of the option divided by the $300 stock price).

If Apple’s dividend is 3 percent per share and the hedge value from the call option is 1-2 percent, that means just a 4-5 percent drop in the stock would wipe out an entire year’s worth of dividend capture.

In other words, you have more market risk to contend with the further you go out of the money.

If you are trading more short-term (e.g., less than 30 days until expiration) and want to go just a few percent OTM, your hedge value will often be less than one percent of the size of your position (and sometimes lower).

(iii) Moderate risk

Choosing call options that are slightly OTM or right around ATM will provide a quality combination of hedge value while mitigating options assignment risk.

You can apply this to a long-term or short-term strategy.

If you go longer-term, you can select call options out 6+ months. Because the extrinsic value of an option (time premium and implied volatility premium) will remain high on a long-term option until the end, early assignment is less likely until the final ex-dividend date within the option’s maturity.

But you must always remember that early assignment is a possibility any time that you are short an option that’s ITM.

If you’re working on a shorter time horizon, you can select call options out 30 days or less. The shorter-term you are, the more you can feel comfortable with selling an ITM call – but not an amount ITM that’s larger than the upcoming dividend payment.

If the stock goes up, then you risk early assignment. However, when the premium of the option you selected is at least comparable to the upcoming dividend payment, then you will collect that option premium if you are closed out early. Accordingly, it could be a bit of a wash in terms of the profit of the trade structure.

If the stock goes against you, then you have an adequate hedge against this via the option’s premium. It also increases your change of capturing the dividend. It will not, of course, protect against a major market move against you.

Conclusion

Covered calls can be used as a tool within the context of a dividend capture strategy.

Overall, covered calls are best in a flat or a weakly rising or weakly falling market. If markets rise a lot, then your upside is capped by the trade structure, so you miss out on those gains. If markets fall a lot, then you’ll still bear some downside – though not as much if you didn’t have options sold against your long position on the stock.

So, you must be prepared to accept the different drawbacks associated with more “extreme” market movements.

Also, be aware that the spreads on options can often be wide. Options are a useful and versatile tool, but wide spreads can often make their use prohibitive. If you are trading options with wide spreads, it is difficult to get fair value and makes it harder to profitably trade options over the long-run regardless of the strategy or way in which they’re employed.

Day Trading using Options

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.

Your DayTrading Options: Near-month and In-The-Money

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.

Another Day Trading Option: The Protective Put

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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Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Process of Day Trading Options for Income

Watch our video on day trading options for income. Our second video below shows an example of how we trade options during the day in under 60 seconds.

Is Day Trading Options for Income a Profitable Strategy?

  • Day trading options can be a very profitable trading strategy, especially when trading weekly options. Many traders buy weekly options with 1-2 week expiration’s, either at the money or 1 strike in the money, and then sell them for profit. Effectively “scalping” their way to consistent gains. Easier said then done though! Buckle up, you have a lot to learn.

Options trading. Oh man what a fun subject! This type of trading is a one way to make money in the stock market that might fit your style.

The video above gives an overview on day trading options and our blog gets deep into it. We help people learn how to day trade options in our trade rooms, so feel free to come and join our community and access live daily streams.

We also have advanced options tutorials under the “members only” section of our website which is for annual members to take their training to the next level.

If you want to learn how to day trade options and build a small account, then join our live trading room! Dan, Signet, Creed and others in the room are showing options trading setups throughout the week.

We are typically using day trading options strategies with high volume, liquid, tight spread, high open interest options that are volatile for day trading.

Check out this Put chart of SPY options! Options charts are an important part of an options traders life.

1. Breakdown

When you purchase an option, you have the right but not the obligation to buy or sell the security at a specific strike price (stock price) .

This means you have the right to buy one hundred shares of the stock you bought the options contract on. Options contracts expire so you can’t hold them forever.

We don’t care about that stuff though, because we are just flipping them like a game of hot potato. Or like a game of musical chairs. You’ll understand the analogy here shortly.

There are two types of options strategies that we day trade regularly. They are “naked” calls and puts. You purchase a call if you believe the stock is going to go up and purchase a put if you believe the stock is going to go down. You profit when the stock price moves in the direction of your call or put.

The “naked” part means you don’t have any shares of the stock when you buy the call or put, and that you’re just buying a call contract or a put contract. You’re just jumping in and trading the contract like you would a share of any stock.

We like to keep an eye on:

  • breakout stocks meaning a daily breakout or range breakout
  • open interest which means there are plenty of people who have traded these contracts
  • options alerts from either Benzinga or bBackBox Stocks which show large option sweeps.

​Here we see Benzinga Pros options alerts window. Here can monitor breaking options alerts in real time, and we can then decide if we want to trade similar options on the alerts that are being shown. Read our Benzinga review and enter bullishbears25 to receive an exclusive 25% off your Benzinga Pro subscription when you’re ready to sign up.

2. Choosing the Right Strike Price While Day Trading Options

When using day trading options strategies you need to pick a strike price and expiration date that will put you in a profit zone when the stock moves.

The expiration date that is closest to the calendar day of the month you are trading on is usually going to be cheaper than choosing one that is a week or two out. However, that doesn’t mean that is necessarily the expiration date you should be trading.

You’ll also need to chose whether you want to be in or out of the money. To help you trade calls and puts, you can use an options chart, such as a chart like interactive brokers or ThinkorSwim.

Most brokers have a call and put chart which will show you what the option is doing on a candlestick chart. These are great platforms to practice on for paper trading options. Take a look at the Facebook ($FB) call chart below.

Here we see an opportunity in Facebook options to make over $200 per options contract intra-day. Who wouldn’t want to learn how to do that? We’ll teach you so you can do it YOURSELF without a trading guru to tell you when to buy and sell.

3. ITM Options Trading

Being in the money means that a call option’s strike price is below the market price. If you are in the money for a put option that means that the strike price is above the market price.

Being out of the money means the call option strike price is above the market price and the put option is below market price. Picking a strike for day trading is important, more on that below.

The first thing you need to do when day trading options is to find the trend for the day. As well as support and resistance.

The trend is your friend. And the trend that you see is going to determine the option you chose it also helps you to determine the strike price you want that day. Support and resistance are incredibly important.

Buy at support and sell at resistance if you’re buying a call. Buy at resistance and sell at support if you’re buying a put. If you need more information on drawing trend lines or finding support and resistance take our day trading course below.

Our courses will help you to get better at day trading options along with watching the live streams.

4. Volatility and Options Trading During the Day

Another thing that we recommend when learning how to day trading options is to pick a volatile stock. You want a stock that is moving, not trading sideways.

Day trading options is different versus day trading a stock, because options can decay in price quickly. Options are a decaying asset, due to the time value function of the option (theta).

With a stock, you can profit even if it moves 10 or twenty cents. With options the more the stock moves “in the money” or into the money, the more money you will make, as the call chart of $FB shows above.

The more expensive the stock, usually the more of a range it has, providing options traders with more opportunity. That’s because its moving dollars a day, rather than pennies.

That’s not to say that a lower priced stock isn’t going to turn a profit but you would most likely need to purchase more options contracts for it to do so. Take our options course to learn more about trading options.

5. ATR Is Important!

There are a couple higher priced stocks that check out each day because I know they usually end up moving at least $5 or more a day. One of the risks to a higher priced stock is that the strike price is more expensive than a smaller priced stock.

You have to be willing to put up money and be OK with losing that amount. We prefer to trade options on stocks with an ATR (average true range) of 3 or more and using a scanning tool is a great way to find them. Take our penny stock trading course.

​Here we see see a FINVIZ scan results showing stocks with high volume, and an ATR (average true range) of at least 3. You want stocks with a high ATR if you wish to make decent returns on your options trades quickly, intraday.

How Much Money Do You Need to Day Trade Options for Income?

  • Many new traders wonder how much money they need to day trade options? Day trading options follows the same margin rules that stocks do. If you do not have an account of $25,000 you are subject to the Pattern Day Trading (PDT) rule. You are allowed 3 same day trades in a 5 business day span with a margin account below 25k. That’s why you want to make sure you pick the right direction the stock is going.

Once you’ve hit the limit of trades you can make because of the PDT rule – you’re done for the week – if you are a margin account..However if you are in a cash account, you an day trade, every day, over an over, until you run out of cash.

Then your cash settles overnight (T-1), an you can do it all over again. 5 days a week. So if you have 5k in an account, you can trade with 5k if all you trade is options, until you run out of buying power. Then you can do the same again the next day

1. Goals

We’ve found that day trading options for income can be pretty profitable in a short span of time. It’s even something you can do for income.

First thing you should do is set a goal of what you want to make that week or even month. Then you should practice in a simulated account before using your real money.

We will teach you how to trade options properly in our trading service. We also show options trading live on our streams.

See what you need to do to achieve that goal and what mistakes you make that hurt your success. There isn’t going to be a consistent flow of money.

You’ll have days where you win and even win big. And days where you lose. Cutting your losses quickly helps to minimize any damage to your brokerage account. A rule of thumb is to always protect your capital!

2. Market Open

We have found that stocks are usually most volatile at the open. But wait to jump in a few minutes before you do. They need to establish their momentum and direction.

So many times we’ve jumped into a stock at the beginning because it looked like it was going one way only to reverse and go the opposite way for the rest of the day. Make sure to learn how to sell options.

If it’s one of those really volatile stocks then you can usually jump in and out all day if you don’t have that pesky PDT rule to attend to.

Or you can, and this is our favorite way to do it, wait for it to find it’s direction get in and ride it out until you think it can’t keep going. Draw your channels and trend lines to find when to take profit.

What Are Good Stocks to Day Trade Options?

  1. Large cap stocks such as $AAPL, $ROKU $AMD, $NVDA, $BYND, $NFLX, $CRON, $CGC, $UBER, $FB, $BABA, $GE, $AMZN, $NIO $MU
  2. Highly liquid
  3. Tight bid/ask spread
  4. High open interest with volume if you’re day trading options. Weekly options with 1-2 week expiration’s
  5. Look for news catalysts

1. Day Trading Options a Fun Side Hustle!

Day trading options and earning some extra income is a great way to trade those big stocks that you can’t afford shares on. It beats working a second job or any 9 to 5 for that matter. The trick is practice, and getting a solid education in the field. It takes time, but anything worthwhile is going to require some effort on your part.

If you need more stock training then take our free courses above. As always don’t forget you can learn how to trade options with the bullish bears team live in our trading room every week!

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