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Cheap Versus Expensive Options

Many traders, especially beginners, are often faced with a simple choice to be made regarding Options Strike and Options Expiration. Even when a trader has defined a trading strategy and decided what expiration to use and whether he/she should buy out of the money, in the money or near the money options the question still remains. This question can often be simplified to: Should I buy cheaper or more expensive options?

To more clearly describe the situation lets assume that we have a trader willing to invest $10,000 in cheap options and $10,000 in more expensive options, where $0.05 per options contract is the cost of the cheap options and $5 per options contract is the price of the expensive options. In this case our options trader would buy 2,000 contracts of the cheap options and only 20 contracts of the expensive options. As a rule the $1.5 per options contract is paid as commission and each trader pays commissions twice - when position is open (options are bought) and when position is closed (options are sold). In our example a trader would have to put $6,000 over the top as a commission for buying and then selling cheap options and only $60 commissions for the expensive options. As you see in the first case with cheap options, our trader has to expect at least a 60% increase in the options price to cover only the brokerage expenses without pocketing any profit. In the case of expensive options only a 0.6% increase in the options price is required to cover the brokerage commissions.

Of course when a trader faces a decision as to what options to buy, the gap between the cheap and expensive options is not as big as in our example. However, this example clearly illustrates the significance of the problem.

Basically, we have a simple choice

  • to buy cheaper options and pay more commissions
  • to buy more expensive options and pay less commissions.

It looks like the answer is very clear, especially with the fact that buying more expensive options is considered less risky in comparison to buying the cheap options. As a rule the cheaper options are more out of the money, and there is a higher chance that they will expire worthless at expiration date and with the more expensive options the more in the money they are, the fewer the chances are that they will drop to zero price.

Even if the answer points in favor of the expensive options, an options trader should always remember such factors as options liquidity as well as the sensitivity of the options to the price changes in the underlying stock. The deeper in the money options are the less sensitive and less liquid, and very expensive options are not very often the best choice for those who expect to close positions with a profit in shortest possible period of time.

Our choice is to buy 1-3 strikes in the money options that are 2-3 months until expiration. As a rule these options are still very liquid and sensitive to the price changes in the underlying stock, yet not very cheap (less commission is paid) and time decay does not dramatically affect them.

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The Information on the Site is provided for information purposes only. The Information is not intended to be and does not constitute financial advice or any other advice. The trading of stocks, futures, commodities, index futures or any other securities has potential rewards, and it also has potential risks involved. Trading may not be suitable for all users of this Website. Past performance is not necessarily an indication of future performance. You absolutely must make your own decisions before acting on any information obtained from this Website.

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