Hey there! If you’re reading this, chances are you’re interested in getting into trading. And you’re probably wondering about the differences between options trading and day trading. Well strap in, because you’ve come to the right place!
In this comprehensive 3000 word guide, I’m going to walk you through everything you need to know about these two popular trading styles. We’ll cover all the basics, compare their unique benefits and risks, and help you determine which one may be better suited to your goals, skills, and appetite for risk.
By the end, you’ll have a solid understanding of options trading vs day trading so you can decide which path is right for you. Sound good? Then let’s dive in!
What Are Options?
Before we get into the nitty gritty, let’s quickly cover what options actually are.
An option is a contract that gives you the right, but not the obligation, to buy or sell an underlying asset at a predetermined “strike” price on or before a set expiration date. The underlying asset could be a stock, ETF, commodity, or index.
There are two types of options:
- Calls – Give you the right to buy the underlying asset.
- Puts – Give you the right to sell the underlying asset.
So calls make money when the underlying goes up, while puts profit when it goes down.
Now, you don’t just get these rights for free. You have to pay a premium for each options contract you buy or sell. This premium price depends on the strike price, time until expiration, and implied volatility of the underlying asset.
The cool thing about options is that they allow you to profit from pretty much any market condition, whether the asset is trending up, down, or sideways. We’ll cover some of the most common options strategies later on.
Options Trading Strategies
Alright, now that you’ve got a handle on what options are, let’s explore some of the ways traders actually use them.
Buying Calls and Puts
The most basic options trading strategy is simply buying calls or puts on an underlying asset. Remember, calls profit when the underlying price rises, and puts profit when it falls.
For example, if you bought 1 monthly SPY call option with a $300 strike price for a $3 premium, you’d earn a profit if SPY closed above $303 on expiration day (strike + premium paid). The more it went up past that point, the more money you’d make.
Buying options allows you to benefit from upside moves in the underlying while risking only the premium paid. Of course, if the asset price doesn’t move in your favor by expiration, that premium is lost.
Credit and Debit Spreads
Spreads involve buying one option and selling another at a different strike price to reduce your premium cost and define your risk/reward.
Credit spreads earn you an upfront premium credit by selling a closer-to-the-money option and buying a further out-of-the-money option as protection. Your max profit is the initial credit received.
Debit spreads do the opposite – you pay a debit to enter the trade but have the potential for larger gains. An example is a bull call spread, where you’d buy a call and sell a higher strike call against it.
Spreads allow you to take directional option positions with lower capital requirements than buying single calls or puts.
Covered Calls and Protective Puts
If you already own the underlying stock, you can sell call options against it to earn premium income. This is known as a covered call. It caps your upside if the stock rises but generates cashflow as the option decays.
Similarly, if you’re holding a long stock position, buying put options underneath protects you against downside risk. Hence the name “protective put”.
Covered calls and protective puts are lower risk options strategies popular among buy-and-hold investors.
There are many more advanced strategies, like iron condors and straddles, but this should give you a taste of how options can be traded!
Benefits and Risks of Options Trading
Now that you have a grasp of some common options trading strategies, let’s discuss the unique benefits and risks options bring to the table:
- Leverage – Options allow you to control large dollar amounts of stock for a fraction of the price. This magnifies your gains (and losses).
- Defined risk – With options, you know your max loss is limited to the premium paid upfront. The underlying can only go to $0.
- Probability – Certain options strategies have high probabilities of earning a profit. Covered calls, for example, are successful around 70% of the time.
- Time decay – Options lose value as they approach expiration. This “theta decay” works in your favor with short option positions.
- Volatility dependence – Options prices rise when volatility rises, giving you ways to profit from uncertainty.
Of course, options trading has risks like any other market speculation. The main drawbacks are:
- Options can expire worthless if the underlying asset price misses your target.
- Trading spreads and other positions requires experience with “Greeks” like delta, gamma, theta.
- Each contract covers 100 shares, so costs can add up for high priced stocks like Amazon.
Overall though, options offer traders numerous advantages not found with simply buying stocks or ETFs outright. But is active options trading better than day trading? Let’s find out!
Introduction to Day Trading
Day trading involves buying and selling securities like stocks and futures within the same trading day, closing out all positions by market close.
Rather than investing or swing trading, day traders aim to profit from intraday price movements and market volatility. They utilize technical indicators, chart patterns, and news events to find trading opportunities each day (or night).
Day traders usually target highly liquid markets including:
- Stocks and ETFs
- Forex currency pairs
- Futures contracts
Some of the most common day trading strategies include:
This means looking for stocks or currencies exhibiting strong upward or downward momentum and trading in the same direction. Moving average crossovers are often used to identify trends.
When a stock gets stuck oscillating between support and resistance levels, range bound traders will look to buy near support and sell into resistance over and over again.
Scalpers try to profit off very small intraday price movements. They may only hold trades for seconds or minutes then flip them for a couple cents gain per share. High volume is key.
Earnings reports, economic data releases, and other news events can produce sharp volatile price swings. Event-driven traders capitalize on this volatility with quick short term trades.
Now let’s take a look at the unique pros and cons of day trading.
Benefits and Risks of Day Trading
- Unlimited profit potential – If a stock skyrockets in your favor, your gains are unlimited. Options have capped upside profit.
- Volatility dependent – Day traders rely on lots of intraday volatility and price swings in order to profit. Low volatility markets make trading difficult.
- Leverage – Day traders can trade on margin, controlling large dollar amounts with a small account balance. But margin also amplifies losses.
- Frequency – Day trading results are highly dependent on trade frequency. More trades = greater chance of hitting winners.
- Uncapped risk – Losses can exceed your account value. With options, you define your max loss upfront.
- Commissions/fees – Trading costs like commissions can eat into profits, especially with high volume strategies like scalping.
As you can see, both day trading and options trading have unique advantages and disadvantages to weigh. But which one is better suited to your personal trading style and goals?
Comparing Options Trading vs Day Trading
Now that we’ve covered the basics of options and day trading individually, let’s directly compare them across a few key dimensions:
Risk Management – Options traders have defined, capped risk per trade. Day traders face potentially unlimited losses if a trade moves against them.
Probability – Options strategies like credit spreads have high probabilities of earning a profit. Day trading is more probabilistic but still reliant on timing and volatility.
Technical vs Statistical – Day trading is primarily technical analysis-based. Options trading employs more statistical concepts like standard deviations, probability, and volatility.
Hold Times – Day trades are closed within the day. Options are held for expiration weeks or months out, allowing more time to be right.
Leverage – Both utilize leverage. But options provide leverage without borrowing or paying interest.
Simplicity – Day trading is relatively simple. Options require knowledge of “Greeks” and advanced strategies to truly minimize risk.
Account Size – Day trading requires $25k+ minimum for margin accounts. Options can be traded with smaller accounts.
As you can see, both options and day trading have a place for active traders, depending on capital, risk tolerance, and personal preferences. Many traders actually combine both strategies too!
And there you have it! We covered a ton of ground looking at options trading vs day trading. Hopefully now you have a solid grasp of the pros, cons, and differences between these popular active trading styles.
- Options offer defined risk and high probability strategies, while providing leverage without margin.
- Day trading promises theoretically unlimited profit potential but subjects traders to uncapped losses.
- Options are more statistics and model based. Day trading relies primarily on technical analysis.
- Day trading requires focus, quick reflexes, and constant availability during market hours. Options offer more flexibility.
Whichever path you choose, the keys are developing a profitable strategy, managing risk, and gaining experience. Start off slow, learn from your mistakes, and you can thrive!
Now get out there, be smart, trade options, day trade, and grow that account! You’ve got this.