Fashion Forum

If you’ve been trading for any length of time you’ll find there are periods in which there are more opportunities than you have leverage available. Recently, a new trading method has become available using penny priced options.

Penny priced options are options that are priced in pennies as opposed to the traditional nickel or dime increments. The advantage to penny priced options is obvious. By reducing the bid/ask spread, it’s more likely you can place a put on a profitable short term position. This is because you’re not paying as much for the privilege of getting in and out of the trade. This advantage opens up a new realm of trading techniques using options instead of the underlying stock. Options allow for a much higher potential leverage than trading the underlying stock.

Of course, there are certain disadvantages to options in the first place. One of them is the time decay as an option approaches its expiration date. You’ll always want to make sure you pick an option whose expiration date is much larger than the anticipated number of trading days. So, for example, if you expect your trade to last for four days, you will want to use an option that is at least forty days out; in any case, not the front month option. The exception to this is when you’re almost certain your trade will simply be a day trade.

Another issue with trading options is that you have to check the liquidity. And of course, it’s always possible for an option premium to flare if there is a sudden and unexpected volatility, which may or may not work in your favor.

Finally, it’s important to make sure you understand the brokerage’s option cancellation policy.

Currently, Interactive Brokers is the only brokerage I’m aware of offering penny priced options, but I’m sure that as this experiment succeeds, other brokerages will make this option available as well.

Here are some tips for working with penny priced options:

o It may take longer to get a fill if you put bids in at penny priced increments than when you use nickel increments.

o Usually I split the difference between the bid and the ask and I work a penny on either side of that split. For example, if the bid and ask are 2.0 and 2.1, I would work a 2.04 and 2.06, depending on whether I was buying or selling.

o Be patient. It may take a minute or two to get the fill, but in a rapidly moving market, the option price may have moved in the meantime. This strategy works best if there is no rapid movement in your stock picks in the meantime.

o Make sure you’re using options that are in the money; that is, the delta is approaching one. Since presumably you are trading on fairly small price changes, you do need the delta to be close to one to get the most bang for your option buck.

Getting a brokerage account that let’s you trade in penny priced options does require some advance planning, but I think once you’ve had the opportunity to test out a trade with penny priced options, you’ll appreciate the wonderful leverage this technique provides.