Short-Term Options

Trading short-term options can be a great way to make money in fast-paced and volatile markets. There is no universal agreement on the exact length of a short-term vs a long-term option – some traders will turn to binaries that span just a few minutes – while others opt for standard options contracts that last days or weeks.

This guide to trading short-term options explores the different investment vehicles available to traders. We also cover the pros and cons of short-term options, from the large profits available to the risks associated with high leverage, for example.

We also unpack questions about strategies and portfolios, supported assets, investing examples, daily tips for beginners, plus good brokers for short-term options trading in 2023.

What Is A Short-Term Option?

Short-term options are a form of derivate that have expiries generally ranging from a few minutes or days to weeks and even months.

Buying a short-term option gives a trader the right to buy (referred to as a ‘call’) or sell (referred to as a ‘put’) an asset at a particular price, on or by a particular date. Short-term options are often used by traders to hedge risk and speculate on various markets, and they can be based on currencies, cryptos, bonds, commodities, and various other underlying assets.

How Short-Term Options Work

A trader who buys a call option is betting that the price of an asset will increase by the option’s expiry time.

Let’s say you believe the price of <em>Apple</em> stock, currently trading at around $150, will go up in the next month.If you bought a one-month call option with an exercise (or strike) price of $150 and Apple’s price rose to $155 by the end of the contract, you would make a profit of $5 per share (minus any fees).

A <em>put</em> option is a bet that an asset’s price will decrease, and it works in the opposite way.In a similar scenario to the one described above, the trader would make $5 per share if Apple’s price fell to $145 by the contract expiry.

Options differ from other derivatives in that if the price moves in the opposing direction, the trader who buys the contract is not obliged to purchase the asset or settle the full debt in cash; they will only lose the premium paid for the contract.

European Vs American Options

You may also hear brokers or traders referring to European and American options:

• An American option can be exercised at any time before expiry, meaning that a trader can end the option at the time of their choosing if they are satisfied with the profit level.
• A European option can only be exercised at expiry, so the asset’s price at the moment the contract ends will determine whether the trade is profitable or not.

Another potential way to profit from options contracts – or to mitigate losses – is to sell them on to other traders before their expiry date.If the underlying asset’s current price means an options contract is set to be profitable, it is said to be ‘in-the-money’, while a contract with an unfavorable current price is ‘out-of-the-money’.

Pricing Model Explained

An options contract’s price is calculated based on the notion of its intrinsic value, which refers to the difference between the current market price and the contract’s strike price, and the extrinsic or time value, which is based on the amount of time left before the contract expires.

Short-term contracts have less time before expiry, thus a lower extrinsic value.

Short-Term Binary Options

For beginner traders, short-term binary options offer several advantages over standard options.

These straightforward contracts offer a simple up/down, or higher/lower, proposition.

For example, will the price of gold rise or fall in the next minute?

If your prediction is correct, you can win a pre-determined payout, typically between 60% and 85%. This means a $1000 bet could see you make between $600 and $850 in profit. In the example below, a 37% payout is offered, meaning $370 in profit.

If your prediction is incorrect then you lose your stake, in this case, $1000.

Importantly, binary options typically offer shorter contract lengths. In fact, some of the best brokers offer contracts that expire after just 30 or 60 seconds. This means traders can speculate on ultra-short-term price movements in cryptocurrencies, stocks, forex, and commodities.

These ultra-short expiry times alongside the straightforward pricing and payout structure mean many beginners prefer to use binary options to make short-term trades vs standard options.

Use our list of the top binary options brokers with short-term options to get started.

Short-Term Vs Long-Term Options

Some traders prefer to make long-term, macro bets where they carefully research the fundamentals of a particular asset and pay close attention to over-riding market conditions before opening a position that can take months to become profitable.

For these traders, an options contract with an expiry time of over six months is standard, with some contracts taking a year or more.

During the 2020 Covid pandemic, stock markets, and some stocks in particular, performed well. However, canny traders saw signs that the gains would reverse once governments stopped pumping money into the economy and central banks started tightening up to curb inflation. This presented a good opportunity for a long-term option play that aimed to capitalize on the predicted downturn.

On the other hand, traders seeking to profit from short-term events over the coming days or weeks, whether these are based on upcoming news events or other opportunities, would seek out short-term options.

Since traders may seek to profit from these options in time periods that can be as short as a day or less, technical analysis can be key in this style of trading. For instance, a trader who spots the best market gap or an upcoming reversal on their charts could buy an option contract and quickly sell it on for a profit.

Alternatively, short-term options can be profitable if a trader uses them to profit from a planned news event. If you buy an options contract before the event takes place, and it moves the market in the way you predict, the contract’s value may greatly improve, allowing you to sell or hold onto an in-the-money option.

With only a limited contract length, short-term options are often cheaper to buy than their long-term counterparts.

The drawback is that, with little time left for the contract to reach the money, it can quickly lose value, resulting in a loss of the trader’s entire stake.

Pros Of Trading Short-Term Options

• Potential For A Large Increase In Option Value– Due to their short expiry periods, they have the potential to increase significantly in value in a short amount of time. As a general rule, people trade short-term options when significant events in the political, economic, or financial world, are on the way, and as such stock and other prices can move drastically. Buying short-term call or put options can be a great way to make large profits from market fluctuations caused by these events.
• Cheaper Due To Lower Time Value– Short-term options by nature have a small window of time after they are purchased before their expiry date, lowering the contract’s overall price.
• Binary Options– Several leading binary option brokers, including Nadex, also offer beginner-friendly short-term options trading. These allow traders to make simple up/down predictions on a range of underlying assets with pre-determined payouts. There are contracts that can expire in just 30 seconds or last minutes, hours or even up to 8 days, for example.

Cons Of Trading Short-Term Options

• Risk Factor– A standard options contract with a short expiry has less time to become profitable.

• While a longer-term options contract provides the trader with some flexibility to reverse towards profit or cut losses by selling the contract, a short-term option’s value can quickly drop to zero with an unfavorable price movement.
• Rapid Loss of Value – As the expiry date approaches, short-term options can quickly lose their extrinsic value. Their theta (or time) decay occurs at a high rate compared to long options, so a misjudged reading of the market can quickly turn a profitable investment into one that yields little or no profit at all.
• Taxes – If you make money from trading short-term options, you may be taxed at a short-term capital gains tax rate, which is typically higher than the gains made from longer-term investments. Therefore, the trader keeps less of the profit made from trading short-term options. Note that you should consult a local tax advisor for guidance on your trading jurisdiction’s obligations.

Strategies & Tips for Trading Short-Term Options

Whether you’re buying a short-term put option or a short-term call option, the goal is to accurately predict the market’s direction using various data analysis methods. Below are some useful indicators and strategies that traders can use when trading short-term options.

Relative Strength Index (RSI)

The RSI evaluates a security’s relative strength or weakness in comparison to other assets in the market.

A rating of 70 often denotes a topping pattern, while one of 30 or below denotes an oversold condition for the stock.

A topping pattern will indicate that an asset’s price is likely to drop, and so will point towards a short-term put option on the underlying asset being the informed investment decision.

In the opposite fashion, an oversold condition will likely result in an asset’s price rising, and as such, encourage the purchase of a short-term call option.

Stochastic Oscillator

Based on an asset’s closing price range over time, traders use the stochastic oscillator to determine if an asset is good value or not.

When the reading is 80, the security is considered overbought (expensive), and when it is 20, the asset is oversold (inexpensive).

In the same fashion as described when discussing the RSI, overbought assets signal a coming drop in price, and underbought assets a rise in price, signaling opportunities for put and call options, respectively.

Moving Averages

The average price of a stock over a given period of time is referred to as a moving average. 15, 20, 30, 50, 100, and 200 days are the most typical time intervals.

Showing whether an asset’s price is trending upward or downward is the main goal. An ideal candidate will typically have a moving average that is inclined upward.

In general, you want to identify an asset with a moving average that is flattening out or decreasing if you’re searching for a solid security to buy a short-term put option for, and vice versa for a short-term call option.

News

Although it may seem apparent, if you’re trying to make a short-term options trade, concentrate on an asset that has a track record of making significant swings over a short period of time.

You can gain knowledge about a security’s price chart and its historical volatility (HV) to learn this information.

In simple terms, a high HV rating signifies that sudden price changes are common. Economic and political events and financial news like interest rate announcements, press conferences, or quarterly reports for large businesses can trigger significant price fluctuations in assets with high HV.

Choosing the correct market swing direction can help a trader earn big profits quickly from short-term options trading.

Final Word on Short-Term Options

The best short-term investment options can bring substantial returns for traders in a short period, but they also involve significant risks. Although a winning trade with a short-term option can be highly profitable due to lower premiums, the short time before expiry reduces leeway, allowing traders less time to reverse unfavorable price movements and potentially rendering out-of-the-money contracts worthless.

It’s wise to invest only what you can afford to lose when trading short-term options or any financial product. For newbies, short-term binary options can offer an easier way to place simple bets on a broad range of markets.

You can begin trading by using our list of the best short-term options brokers.

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