Options Scalping Part 2

Options Scalping

Options Scalping Part 2

 

Welcome to part 2 of Options Scalping! Some basic considerations were discussed in part one, and in this installment, we will introduce other pertinent subjects that play a big role in successful options scalping. We will begin with six general tips that are very useful for scalping options. Then we will move into more detailed specifics regarding choosing a winning scalping setup and will finally discuss a specific way to enter, maintain, and exit a scalp trade. As is always the case, if you are very new to trading options be certain to move slowly before you risk your money in the market.

 

TIP 1: KNOWING YOUR BROKER
This is a very basic piece of advice, but you need to really understand the broker you are using. When scalping, it is not the time for googling how to set a stop loss on your mobile app, or any other mechanical specific. You should know how your broker’s desktop and/or web applications work as well as the mobile app. Sometimes computers crash or WIFI routers finally give up the ghost. Knowing how to navigate your broker’s mobile app can stave off disaster in certain cases. Additionally, if you primarily trade on mobile be certain you are familiar with the desktop and/or web application. You don’t want to lose your phone at a crucial point in a trade. Be aware, at the least, how to place limit, market, stop, and take-profit orders. Also be aware of how to add to and scale out of a position. Additionally, be certain you know how to move your stops up in the merry case of a trade going your way. There should be no question how to do these things before you enter a scalping position. Remember, scalping positions are often relatively large in that they hope to secure a small profit on a larger number of contracts. Even with ten contracts open, if a trade reverses violently, severe financial damage can occur. Know your broker. Call their trade ask and simply ask them if they discourage scalping in any way. A great general rule is getting to know your broker’s trade desk. They are very helpful.

Additionally, know how good your broker’s fills are. In scalping, the name of the game is to get in and get out quickly. With some brokers, traders do feel confident simply market ordering in and out of positions. They know their broker fills quickly and well. Other traders know that their brokers do not provide quality market orders. In this case, they understand they have to take the added step of placing limit orders. Sometimes this is onerous, so it does behoove you to use a full-service broker known for good fills. This blog does not recommend any particular brokers, but many of them are well known for good, and bad, fills. Do your due diligence and know your broker.

 

TIP 2: USE A CASH ACCOUNT (AND KNOW ABOUT FRIDAYS AND ZERO DTEs)
Perhaps the single biggest complaint of the new trader is what’s known as the Pattern Day Trading rule, or “PDT” in common parlance. This restricts traders in margin accounts to no more than four round-trip trades in a seven-day period unless they maintain a balance of more than $25,000. Traders often sign up for margin when they open their account, but there is another option called a “cash account,” and in our opinion virtually all options scalpers should have a cash account. First, very few people who trade options truly need anywhere close to $25,000 in a trading account and very few need margin as well. A cash account is not subject to the PDT rule. You may simply make as many trades as you wish as long, of course, as you have the buying power. The leverage of options means that it is possible to make very good gains with a three to four thousand dollar cash account.

Additionally, if you are scalping ODTEs on a Friday, be aware that many brokers will close your trades out automatically if A) they are in the money or close to being in the money and B) you don’t have the buying power to assume 100 shares per contract of your options if they were to be assigned. A large number of traders like to trade ODTEs on SPY, for example. It is also likely that a majority of them do not have the buying power set aside to handle buying 100 shares. Therefore, many people find out about this automatic closing on Fridays. And, as an added danger, most brokers will charge a fee of 50 to 100 dollars to close these trades out for you. Added expense to avoid as an options scalper.

 

TIP 3: KNOW THE BEST TIMES FOR SCALPING
Remember, the goal is to be able to open a fair number of contracts at a correct place in the chart in accordance with a pre-arranged trade plan and sell them at a small profit in a short amount of time. Being able to do this repeatedly is the end goal, and this is what brings the large gains that many options scalpers enjoy.

There are, truly, about as many approaches to options scalping as there are options scalpers. Typically, volume and volatility are needed to benefit from quick moves. Sideways price action is the enemy of the scalper. Therefore, scalpers often prefer the first two hours of the regular trading session or the last hour. These are times that have many active market participants, and volatility is often there.

Volatility and range are what the scalper seeks. Other than the general market times of open and close, volatility is also often present in sessions very close to earnings reports and other market moving data events, such as FOMC meetings.

 

TIP 4: KEEP PnL OUT OF IT
This is a very useful tip that entirely falls into the category of “easier said than done.” The very best way to manage an options scalp is to rely on the data that price action, volume, and your chosen indicators are providing. Remember that you should have analyzed the chart well ahead of the trade, and you should know exactly when you should exit a trade if it goes well or badly. Rely on support and resistance and this date for your exits. Often, traders will exit a trade at a predetermined profit or loss. Imagine the “I am wanting to make one hundred dollars on this trade” or the “I am willing to lose fifty dollars on this trade” approach. While that is, of course, psychologically sound (it is what you are comfortable with, after all, that is only defined by the individual), it is not data-informed. Additionally, the maret does not care about how much you are willing to lose or hoping to win. If you sell at a predetermined subjective price point, you may still be in a trend going your way. This leads to the much-dreaded “leaving profits on the table” that can have a negative trade psych effect. Conversely, if you sell at your subjective fifty dollar loss, the price action might be right above a major support level. This can result in you locking in your loss on the scalp, price bouncing, and you watching aghast as your forever-red trade ascends into profit. It is very hard to do so, but if you can take PnL off your chart when you are in the heat of an options scalp, it can be a very good decision.

 

TIP 5: SEEK MECHANICAL EXITS
Related to tip number four, mechanical exits are the goal of every scalper. The goal is to make frequent trades with your winners being much bigger than your losers. That is the core nature of scalping; it seeks to take small profits with relatively large positions over a large number of trades. You do not have to use a large position, of course. Many traders scalp one contract at a time. But if you do take larger scalp positions, it is imperative to have strong exit discipline. Options scalpers take many losses; they stop out frequently. For this reason, scalpers must ensure they start with small starter positions and only add to winning positions and if they are wrong, they stop out immediately with their one contract. A string of five percent losses with a single contract can be easily overcome with a single win of 20 percent with multiple contracts. The option scalper’s don’t necessarily have to outnumber his losses percentage wise, but they do have to be much bigger in terms of net PnL. So to do this, not only do you have to be on point with your trade psych, good on your entries, hyper aware of your total transaction costs (commissions, etc.)…but you also have to exit as mechanically as possible.

Often, scalpers use support and resistance in their charts to determine where to take profits or losses. Whether you are using charted levels as static resistance or a dynamic resistance (the 8 and the 9 EMAs are very widely used), it is the chart that should tell you when to exit. This can keep help keep your losses small and your wins larger than your losses. Be aware of volume as well. This is one thing that can override a predetermined resistance exit. Remember that price action doesn’t care where you think the support or resistance is. After all, in its most basic format, the support and resistance we carefully map out are just subjective lines we drew on the chart. Consider negative possibilities: we could be wrong. Obvious support and resistance may be taken out by a myriad of happenings. News might happen. Algos might fire. If a sudden onrush of volume takes a trade in an undesirable direction, be sure to have mechanical exits. Options scalping depends on faithful adherence to a specific strategy and a set of rules. If you are not good at following these rules, or if you don’t have a specific strategy in place, don’t trade with real money. Paper trade until you think you are ready to start very small in your options scalping adventure. Do not simply jump into green or red high volume candles.

 

TIP 6: SCALP THE SAME THINGS
When you are new, I think it is helpful to scalp a handful of tickers at the most. You need to get familiar with how a certain security moves. It is useful to stick with just one, in fact, when you are starting out. Many traders begin scalping single contracts of the SPY ETF and focus only on it in lieu of being too scattered across several individual companies. Charts always look basically the same, but this can be problematic. All tickers are unique. Volume comes in differently and other elements differ as well. Many successful scalpers might have a basket of names they scalp and not vary much from them. Commonly scalped tickers must have good liquidity. Common ones include the SPY and QQQ ETFs, AAPL, BA, NVDA, TSLA, AMZN, and many other household names. If you are new, however, avoid the megacap tickers. Stay in the names that move less massively.

 

COMING UP
In part three of our options scalping series, we will discuss more granular details as well as provide a method to enter, maintain, and exit a scalp trade. We’ll also cover more nuanced topics such as having a written trade plan, delta selection, dynamic support and resistance, commonly used indicators, and the wash sale rule, and more. Always trade responsibly, and don’t trade alone.