How To Pick The Best Option Contract In 2023 For Option Trading
When I first started option trading, and saw a list of contracts to choose, I was confused and scared. My biggest question was, and still to this day is, “what is the best option contract to choose?”
The answer is to that question is, any option contract that has the following indicators:
- Good volume activity
- Good Implied Volatility levels
- Good spreads between ask & bid prices
- Liquidity
In this article I will be discussing what indicators I look for when searching for the best contract.
Indicator #1: Good trading volume
The first indicator I always look for in option contracts is the volume.
The volume indicator shows the total number of that individual strike price contract being bought and sold for the day.
Let’s take a look at $PCG
If I wanted to place a call for $PCG, and if I’m giving a list like the picture above, I’d pick the $13 calls because the volume is higher than the rest of strike prices.
If I picked a contract with low volume that means their’s not enough activity going on that contract strike price which would probably make me lose money.
these are the simple factors to keep in mind.
High volume + price increasing = strong uptrend
High volume + price decreasing = strong downtrend
Low volume + price increasing = weak uptrend and the value of the contract won’t move much.
Low volume + price decreasing = weak downtrend and the value of the contract won’t move much.
The minimum volume that I look for in an option contract is 800 and above. Otherwise I will not take the contract.
Indicator #2: Low Implied Volatility levels
Think of IV (implied volatility) as the suspense around a certain event that causes a stocks premium to run up. Essentially you want to enter a trade when the IV is low so that you’re not affected by the IV crush!
A high IV percentage is typically above 80% and low is below 80%.
Let’s take a look at an example with $TSLA
I picked the $1,100 call contracts for Feb 04 2022. Following my first indicator rule, I picked a contract with high volume (22,168 shown in the image above).
Now I checked the IV percentage, and it was below 80%. This is a good percentage that will not crush your option contracts on simple cent moves.
The upside is that volatile stocks is that the price swings can create a large amount of profits if entered end exited at the appropriate time. The downside is that those same price swings can really take large amount of your profits if you get caught at the wrong side of a trade.
I generally like to sell my contracts before the IV gets high. I don’t want to turn a green trade into a red trade.
Indicator #3: Good spreads between ask & bid prices
The spread is the difference between the bid and ask price of a stock. The ask price of a stock is the lowest price someone is willing to sell a share of stock for. The bid price is the highest price someone is willing to pay for that stock share. For example if a stock has a ask price of $8.50 and bid of $9.00 the resulting spread is $0.50.
Generally for day trades you want to look for stocks that have very tight spreads. The reason for this is that if you need to exit a bad trade this can help minimize your losses since you can sell as close to market value as possible.
This takes an even larger importance for options contracts as single cents can decide profitability. Buying a contract with a wide spread can immediately put you in the red before you even start, let me explain.
Let’s say $TSLA has a $0.10 cent spread on its options contracts. For simplicity’s sake lets say the ask is $1.10 and the bid is $1.20. Everyone will be trying to buy the contract at the ask price but there might not be people selling at ask as they deem the price too low. If you’re forced to buy the bid $1.20 then you’re already $0.10 down on every share since people are trying to buy in at $1.10. So you will need to make up that gap before you can become profitable.
Comparing this to a stock that has a 1-3 cent spread the gap you need to make up is significantly less. This will also benefit you at selling time since the prices will be closer together.
Indicator #4: Liquidity
Liquidity refers to how many shares of a stock can be bought or sold without adversely impacting the stock price. And how easy it is to buy and sell those shares. This is important for day trading because seconds matter, seconds in day trading cost or make you money. I can’t stress this enough, being able to enter and exit positions at will is extremely important to maximize gains and minimize losses.
Finding Stocks
Alright now that we got the indicators out of the way we can look at how to actually find these stocks. In order to make the process simpler day traders use applications called “screeners.” As their name implies the software screens stocks based on your chosen indicators and parameters. Most brokerages like Webull, Fidelity, TD Ameritrade offer their own stock screeners. You can also use online applications like Finviz and Zachs, your screener of choice comes down to personal preference.
Conclusion
The profitability of day trading largely depends on the strike price contract that you pick. In order to maximize the chances of profitable trades day traders use screeners in tandem with day trading indicators to make educated choices on what stocks to trade. In future articles I will be discussing how to look at charts to find good opportunities to enter and exit trades.
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