Options trading volumes have soared in recent years, a sign that more people are getting into the options trading business. If done correctly, option trading can be hugely rewarding for retail investors. But you could also lose big in the options market if you don’t know what you’re doing. Knowing the best time to trade options can make the difference between a profitable and losing trade.
If you believe options trading is for you, learning a bit about options trading strategies can set you on the path to consistent success in the market.
People trade options for a variety of reasons. For example, while some are into options trading for income, others do it as a means to hedge risks on their primary investment portfolio. Therefore, the best time to trade options may depend on the reason for trading.
How Does Options Trading Work?
It can be easier to determine the best time to trade options if you know how options work and the type of option you’re handling.
An option is a contract to purchase or sell a package of shares of a stock, ETF, or other investment products. A single option contract typically involves a package of 100 shares. The common types of option contracts are “call option” and “put option.”
If you purchase a call option, you get the rights to purchase the investment product represented in the contract at a certain price within a specified time. You would purchase a call option if you’re bullish on the investment product.
Let’s say you think that Tesla stock will rise in the coming months, but you don’t yet have the funds to buy the stock immediately. In that case, you could purchase a call option for Tesla stock. That would only require you to make a small upfront investment.
On the other hand, if you purchase a put option, you get the right to sell a stock at a certain price within a certain period. You would purchase a put option if you’re bearish on a stock.
Let’s say you think Amazon stock will decline in the coming months. In that case, you could purchase a put option for the Amazon stock. That would allow you to sell the stock at a favorable price in the future.
Options have expiry dates. If you fail to use up the option within the specified time, the option expires. Let’s say you have an option to buy Tesla shares within 60 days. If you don’t exercise the option within that period, the option will expire, and you won’t use it again.
How Does Option Premium Work?
When you purchase an option contract, whether a call or put option, you pay a price call premium. The premium is the cost of the right to buy or sell the stock represented in the contract. Therefore, the option premium is set by the contract seller and it is calculated on each share of the stock.
The premium can be set at $3 a share, which would work out to a total of $300 for an option representing 100 shares of a stock. That becomes the cost to the investors purchasing the option. On the other hand, the premium is the income for the investor selling the option contract.
If you purchase a call option, the premium is on top of the cost of the shares involved in the shares. Let’s say the option allows you to buy the shares at $130 apiece. It means the shares alone would cost you $13,000. Including the $300 premium, the investment would cost you.
But you would only need to put down the premium to start the trade. If the market doesn’t move the way you expected and you fail to exercise the option, you will only lose the premium.
The premium on an option reduces as the option’s expiry date draws near. And this is one reason it is important to time your option trades correctly.
When Is the Best Time to Trade Options?
The best time to trade options is when you can maximize your profit. This means that the best time for trading options may not be the same for all traders in the market. That said, there are a few factors to take into account when deciding when to trade options.
To be clear, option trading has two sides: the buyer and the seller. It goes without saying that trading conditions that favor an option seller may not necessarily favor the buyer. As a result, option sellers and buyers would approach the timing of their trades differently to maximize their profit.
Whether you’re a buyer or seller, these are the important factors to consider to help you decide the best time to trade options:
1. Option Expiry Date
If you purchase a call option expiring in a year or so, you would have ample time to prepare your finances to buy the stock represented in the contract. Moreover, you would have more time to allow the stock price to move toward your target. But that also means waiting a long time to turn a profit on your trade.
On the other, an option contract that expires in a month or so allows you to turn a profit on your trade more quickly. But it doesn’t allow you much time to prepare your finances to buy the underlying stock.
If you are a new trader, experts advise that you should initially focus on option contracts expiring in 30 – 45 days.
2. Premium Costs
With options, the longer the expiry date, the higher the premium cost. And the opposite is true. The reasoning is that an option with a long expiry date allows you more time to wait for the stock to move toward your target. A short-dated option doesn’t give you that privilege.
Since investing is as much about controlling losses as it is about pursuing profit, it may be prudent to initially target options with short expiry periods. With short-dated options, you would pay significantly reduced premiums.
3. Market Volatility
Market conditions cycle between low volatility and high volatility. In a high volatility condition, stock prices move frequently. On the other hand, low volatility is characterized by slow price movements.
A low-volatility environment works best for those purchasing options. However, a high volatility environment is more favorable to those selling options. One reason you should take market conditions into account when trading options is that volatility affects option premium costs. Premiums move down with low volatility and go up with high volatility.
Final Thoughts
The best time to trade options is when you can make the most profit on the trade. Consider market volatility, premium costs, and option expiry dates when determining the right time to trade. And if you’re wondering what the best time of the day to trade options is, the options market is usually most liquid in the first hours after the opening bell and the last hours before the closing bell.
