Listed options trading involves the use of complex strategies to take advantage of the market pricing inefficiencies. Therefore, the trade requires an understanding of many sophisticated concepts. To be successful, you have to be willing to take and internalize those concepts.
There are various trading styles in the options business, and each style produces different results. Whether you are a professional representing an institution or a private individual, you can increase your chances of making money by applying the following styles:
- Day trading
- Swing Trading
- Position Trading
- Use of Market makers
Day trading is a term used in financial markets to describe the buying and selling of options on the same trading day to profit from short-term price movements. In this case, a trader holds a position for a short period, usually from several seconds to several minutes but not longer than a day.
The majority of day traders are individual or small institutional investors. Day trading allows one to have quick gains and losses due to market price movements. Day traders generally use the technical analysis strategy of predicting the future trend of options by analyzing past data. However, day investors are constantly on the lookout for any price changes, which is time-consuming.
Swing trading means trading a stock option for days or weeks and then getting out and never holding it for more than a couple of weeks. Swing traders spend most of their time trying to spot promising sectors and stocks. A swing trader looks for the price momentum of an option and trades the contracts according to how they perceive the underlying security to move.
Ideally, you enter a position and exit in a matter of days or weeks, depending on how long you project the price momentum to last.
Swing trading is suitable for part-time options traders. It is a preferred style for trading options because they are typically short-term trading instruments. In addition, swing trading provides a middle ground for day traders who do not have the time to continuously monitor the markets for the right time to enter and exit positions.
Position trading is the most suitable style for trading options and futures because of its low-risk attributes. However, it requires a more profound knowledge of the mechanics of options trading and is primarily a preserve for professionals.
Unlike the other two types of traders, position traders don’t focus on the daily market movements or try to catch small swings. Instead, they hold onto their positions for a more extended period. As a result, the position trader is more of an investor than a speculator and depends on the long-term outlook of a stock’s price behavior rather than its short-term price swings.
This trading style involves opening or closing out a certain number of shares or contracts for one particular underlying commodity for an extended period such as weeks, months, or even years.
The ultimate goal of this style is to minimize risks rather than aiming for higher profits. As a result, the profit margins are low, but the investors trade with huge capital for worthwhile returns. Hence the reason why the style is suitable for banks and large financial institutions.
A market maker is a firm, or knowledgeable individual, that quotes both a buy and sell price in derivatives or securities to provide liquidity. It stands ready to both buy and sell, thereby creating a two-sided market.
They are professionals who ensure that the options exchanges are liquid enough for traders to execute their transactions. Market makers are usually employees of financial institutions and have a role in ensuring efficiency in the options markets by buying and selling in large volumes.
The primary role of the market makers is to ensure the smooth operation of the options exchanges by maintaining portfolios of various contracts and trading on them in the absence of a willing buyer or seller matching the existing order. Without them, it would be harder to buy and sell options, and there would be fewer transactions, and exchanges would stagnate.
For their role, the market markers access some privileges that enable them to make money. They benefit from the spread, which is the difference between the ask price and the bid price.
Options are an integral part of trading. If you are planning to trade online, it becomes essential to know all the ins and outs of options trading, given its importance in financial markets. However, keeping the risk level in the proper perspective is necessary as options are highly speculative and rewarding if you can manage your risks.