DAY TRADING vs. SCALPING OPTIONS: Option Strikes; What to choose and when? Alright this is a good learning lesson for everyone in my opinion when it comes to daytrading/scalping OTM (out of the money) strikes. Let's break down TSLA's move today. Now TSLA has had a nice 6% up day, however, TSLA's momentum was and is dry. its move up today was very gradual and better watched on the 5 and 15m chart in comparison to the 1m chart. SO this makes TSLA today as a day trader (watching 5min and 15min) rather than a scalp (watching 1min). Now when it comes to day trading or even scalping a stock like TSLA, what strike you choose is very crucial. I tend to like to scalp or day trade ATM strikes. However, if my account can't afford it I will scalp an OTM strike. Now, it's very important to note that when you trade OTM strikes, your trading needs to be adjusted. Meaning, you can't hold onto an OTM strike hoping to make money if TSLA pushes up. Why? Because you have the Greeks like Theta Decay and other factors like Implied Volatility moving against you. So let's take today for example as a DAY TRADER: Day Trading ATM Strikes TSLA had a nice run like I said, but its run is a very gradual up day. When it comes to a day like this its best to day trade it, meaning buying an ATM call and watching the 5min chart for an exit. Here’s why: let's look at the break of the key level 700 to day and compare its price movement to an ATM 700 call strike and a further ATM strike of 710 ( wouldn't consider this as an OTM for a stock like TSLA) 5Min Chart We see a nice break of that key level 700 on TSLA Now as a day trader, Entry w ould be confirmation of a close above 700 which in this case would be at this second 5min candle start (white arrow above). Now let's assume we held TSLA all day trying to day trade it to that key level of 720s; while still following our game plan of a mental stop loss of course. Not just holding it to hold. Looking at the graphs of the option contracts you can see that the 700 Call strike: Assuming we are buying just 1 contract: We would have gotten in with an Entry at around a price of $23; this is when TSLA gave us that 5min candle confirmation for entry …. And holding it until now we are green with the value of the option premium being at a current $29. Entry Value= $23 (x 100 since 1 contract always gives us 100 shares) = $2,300 Exit Value= $29 = $2,900 So we are green $600. Which is a 26% return thus far. Thats fantastic! Same thing with the a little further strike of 710 Call : Purchasing it at where we said we would (the 5min close above 700 key level on TSLA), would give us a rough Entry estimate of around $19… holding it until now. Our premium would be worth $22. Again, assuming we traded 1 contract Entry Value = $1,900 Exit Value = $2,200 So, we are green $300 if we took this strike instead. Which is a return of about 15%. That is still great! But not as fantastic, right? Looking at the first example of the ATM 700 strike option call or the 710 strike option call; we would still be green and profitable regardless of all the consolidation happening with TSLA’s stock price. This is because: 1) Time Decay: we are trading on a Monday so theta doesn't hit us as hard 2) Uptrend: We had a nice big move on TSLA and our strikes are now ITM (in the money). 3) IV: TSLA’s IV is average so IV crush does not affect us on every pullback or consolidation. Now, it's important to note that in just comparing these two strikes, there is a big return percentage difference. This shows us that if we are looking to day trade a stock, it's best we stick to trading ATM strikes. Yes, the further one of 710 is still profitable and could be great, BUT if your account can afford to trade ATM, then maybe that’s the best bet. If not, a strike like 710 would suffice. Before I break this down some more, I want you to see the comparison of day trading the 700 ATM and the 710 further strike vs. an OTM (Out the Money) call strike of 800. Day Trading OTM Strike Now looking at the very further Out the Money OTM 800 Call Strike: Our entry at the same spot as before would get us filled at around $1.7…. And although TSLA is in an uptrend and making new highs on the day, our premium is taking a big hit!! With the value of 1.37… This makes us red $33 on one contract...about 19% loss. That is a BIG loss.. And for what? Imagine if you were to invest the same amount of capital in the previous trades? This means buying about 10 OTM contracts to value your entry at $1,700 and your exit at $1,370; thus being a loss off $330. Still the same losing percentage, but this trade gives you a higher probability of being in the red. So why even take it? TSLA was in an uptrend, making nice moves, but we’re still red? Yes. Thats because the OTM Option Call: 1) Time Decay: Loses value as time goes by because of Theta 2) Probability: Is so far from being ATM (based on the Greeks). Based on the greeks and probability analysis, what are the chances of TSLA hitting $800 this week? Could there be a chance? Yes, so as TSLA goes in an uptrend so does this Option Call strike..slowly. However, the moment we get that slight pullback in TSLA’s stock price is the moment the premiums and value of this Option Call gets slashed and takes a hit. The further away we get from the 800 mark, the cheaper and more the premiums will get hit because the probability of TSLA hitting 800 becomes less and less. 3) IV: As stated previously, Implied Volatility on TSLA today isnt too bad and is kind of average. However, on days where IV is higher, once that IV were to pullback and crush, it would also crush the premiums even harder. These 3 reasons are why trading OTM Option Contracts are so risky I know it looks tempting to trade a stock like TSLA when you have a small account; and it's doable. But day trading weekly TSLA with OTM option calls 9 times out of 10 does not make sense. SO you might be thinking..okay then how do I trade them? Well, this is where being an option scalper comes in play *evil laugh* hehe Now let's take today for example as a SCALPER: As a scalper our main focus is entering and exiting a trade quickly while holding EXTREME discipline. Meaning entering because of confirmation and exiting because of confirmation. This also means: NO adjusting mental stop losses to give the stock a ‘second chance’ NO entering before confirmation just to get a ‘better entry’ NO holding on to a losing trade because of anger NO holding on to a losing trade because of hope NO holding on to a winning trade because of greed Simply put, follow your trading plan. Enter for a reason, and exit for a reason. Do not keep adjusting your trading plan during the trade, your trading plan should be set PRIOR to entering the trade. You should also set a profit taking level or levels. As I do, I tend to take some profits off at intra-day levels and go from there. Once my highest PT has been hit I exit immediately. Oftentimes, I will exit the whole position if my trading plan was to do so. There's nothing wrong with taking profits before other traders do. If you were to follow what the other 90% of traders do, you would be part of the 90% that fail. Be the 10%. As a scalper, trading is super lucrative if you can just focus on the discipline aspect mentioned above. So, let's look at the SAME exact TSLA trade but in terms of a scalper rather than a day trader: As a scalper, playing the break of 700 to me means one of two things: 1) Risker Trade ( this is done when you have profits on the week or month and can afford to do so): Getting in before the break of 700. a) Just to note, getting in before the break of 700 does not mean getting in at 697. It means getting in when the momentum starts picking up and the Asks on LVL2 start holding 700s or etc. You need to see price action support your decision, not just getting in at 697 because you think TSLA will break 700. 2) Safer Trade (this is my strategy as a scalper does not mean it should be everyones or is the right s trategy): Waiting for the 3 candle strategy to hold 700s. Meaning we see that the first candle breaks and closes above 700, then the second also closes above 700. And the third one is where we take our entry If t he third candle continues in the direction we are looking to see it move. Otherwise, it's best we wait for that third candle to completely close and enter at the start of the 4th. In this example we will break down the safer trade of waiting for that 3 Candle Confirmation. 3 Candle Confirmation Entry for a Scalp on TSLA Looks like our Entry would be at 7:10AM which is when we see 3 candles confirm the hold above 700. The entry of 7:10AM is our fourth candle and that is when we enter. Now as a scalper, I like to set my intraday levels to know where I would like to take profits. In this trade example I have levels at 703, 706, and of around 708. For the sake of this example, let's assume we take profits at our higher PT of 708. Scalping ATM Strikes Here is what it would look like to SCALP TSLA with a 3 candle strategy hold for both the 700 calls and the 710 calls: 700 Option Call This shows that we would have entered when premiums were valued around $22. Assuming we bought 1 contract Entry= $2,200 And exiting at our key level of 708 on TSLA means we would exit when premiums were worth a value of $27 Exit= $2,700 Profiting $500 from this trade in just about 10minutes…23% return. That is amazing! As a scalper, we get the opportunity to make great returns in shorter periods of time. BUT ONLY IF we stick to our plan and eliminate greed, ego, and fear. Because, this trade could have easily been red if we held with greed or ego, or even letting fear keep us away from taking this trade. Or the 700 Option Call Same exact trade would mean our Entry would be at $18 Assuming we purchased just 1 contract: Entry = $1,800 And our exit at TSLA’s 708 intra-day price target would mean our premiums would hit $22 Exit = $2,200 Profiting $400! … which is a return of 22% Wowza! Showing us that the difference between scalping the ATM 700 call and the 710 further call gave us about the same return. 23% vs 22%. A slight difference of about 1 or 2%. In just 10 minutes. However, with day trading these the difference was much wider. Returns of 26% vs 15%. Ouch wider difference of about 11%. In about 2 hours. That’s crazy right?Now before we talk about this more let me show you scalping that same 800 OTM strike that would have made us a big losing trade if we held ALTHOUGH TSLA had a nice uptrend on the day. Remember, day trading that 800 call strike left us with a loss of about 19% even though TSLA had a good uptrend. Now lets look at scalping such a far OTM strike 800 Call Strike So our entry here would be of course when TSLA held 700 with 3 candle strategy; meaning our Entry was when premiums were valued at $1.6 Assuming 1 contract Entry= $160 And selling at that 708 key level means selling when premiums hit the value of $2.0 Exit = $200 Making profits of $40! Which is a whopping 25% return!! On an OTM strike. Assuming you invested the same amount of capital as an ATM, buying 10 contracts would mean making $400 profits on this trade. So, do you see the difference? Choosing Strikes based on Volume and Open Interest I personally like to only trade option contracts that have an Open Interest of at least 1,000 You can easily find this on your trading platform: I use ThinkorSwim by TD Ameritrade By clicking on the Trade tab up on the top left of your screen > changing the Layout option on the Option Chain row to Volume, Open Interest, and voila! There it is, you can see the underlined numbers show option strikes for TSLA that have very high Open Interest. I would trade these ones because they have over 1,000 in open interest. You see how the other strikes on the screenshot have around 100? That shows low liquidity and would be hard for a scalper to get quick entries and exits. Therefore again, I personally like to scalp or even day trade options that have higher than 1,000 Open Interest. Conclusion It merely depends on you as a trader and what YOUR TRADING PLAN is. Which again, should be figured out and noted prior to entering a trade. If you are looking to day trade; maybe its best you day trade stocks that you can afford ATM and closer to ATM strikes for. If you are looking to scalp trade; then you can most definitely scalp further OTM and benefit off of paying less for the premium. However, you need to be VERY strict with your trading plan. Because if you hold with greed on an OTM strike like the example above, your premiums will just dump right back and you will be flat or most probably red on your trade. So, if you are looking to scalp make sure you are scalping.. Meaning, execute your plan. Do NOT hold with hope.because that just then becomes a day trade. Key Points: ● Watching 5min and 15min charts when day trading for confirmation for entries ● Watching 1min chart for scalping; glancing at 5 and 15mins for confirmation of trends and intra-day levels ● Setting a mental stop loss and profit taking levels prior to entering a trade ● Focusing on day trading ATM/ closer to ATM strikes ● Focusing on scalping a strike with higher than 1,000 Open Interest. ● Time Decay and Implied Volatility both play a big role on how your premiums move and react. ● If you are going to scalp an OTM contract, be sure to be quick and follow your trading plan. Do not hold with hope because any slight pullback will wash your premiums right back down and you will end up flat or red on the trade. ● Execute your Trading Plan, do not adjust mental stop losses or hold with hope or because of ego. If you are wrong on a trade, then you are wrong. It’s okay, it happens. Let go of that ego of wanting to always be right and cut your losses. Smaller red days or red trades will yield stronger returns on your green days.
