Trading costs are high

by sabitha 2010-11-23 12:40:58

The combination of poor executions, wide bid/ask spread, and commissions can make even a successful options trade less profitable than it ought to have been.
a) Bid/Ask spreads are wide

Even when the executions don't go bad, the bid/ask spread is usually wide, which has the equivalent effect of a bad execution. If you buy an option for $0.75 and sell it immediately, it is quite common that you might receive only $0.50 for it, a loss of 33% plus your both-way commissions. [2007 note: with decimalization, bid/ask spreads might be somewhat less wide now than they were in the 1980's.]
b) Poor executions are frequent in options

Options markets lack liquidity, and specialists sometimes seem to take questionable liberties with the pricing of "at market" orders, and in one particularly bad case, my order was simply overlooked:

I owned options on which there was a Good Till Canceled limit sell order. During one day, the option price spiked well above my sell limit, then plunged back to near zero, but never during that time was my sell executed. I obtained written proof of the price history during the day and presented it to my broker. They credited me with the sale at my limit price, but I suspected it was partly because I was an active trader and they wanted to keep a customer.

One can hope that better computerization of the markets (and better oversight of specialist activities) has made bad executions less frequent, but there remain some situations where if an execution goes bad or you are unable to get your trade executed due to factors on the trading floor, you are just out of luck. (See the OCC Options Disclosure Document.)
c) Commissions on option transactions are high

Your options must make a significant move in the right direction just to overcome your commission costs.

1987 brokerage commissions were about 3 times today's rates, so it was a more important factor then. Nonetheless, if you trade on paper to discover if you will be good at options trading, always calculate and include the actual commission costs that would be charged.

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