The Five Cheapest Ways to Trade Options

05/16/2014 8:00 am EST

Focus: OPTIONS

Kenneth Trester

Editor, Maximum Options

Due to options' short life span, option portfolios tend to have a much higher degree of trading activity than stock portfolios, which means that options traders must be very aware of commission costs because they can add up quickly, eating away at your bottom line, says option expert Ken Trester of MaximumOptions.com.

One of my tips has always been to select the cheapest strategies, i.e., the strategies that incur the smallest commission costs per dollar invested. The ideal strategies are actually the simplest, because the fancier the strategy gets, the more expensive it is.

So here are the five options strategies that incur the lowest commission costs, beginning with the most attractive from a commission standpoint and following in descending order.

1. Buying Options
When buying a call option or put option, you are only required to pay one commission when you enter the position, and if you exit that position, there is only one commission charge, which nets out to two total commissions.

If you are absolutely wrong about the direction of the underlying security, you may never have to close out the position, because it will be worthless before you can take any kind of constructive action.

Therefore, the commission costs in buying options are low, especially when you are working with the simplest strategy, which is buying very cheap options and hoping they will appreciate.

2. Writing Naked Options
Along with buying options, writing naked options create the smallest commission costs.

When you are writing naked options, in many cases-especially if they are way out of the money-you may not have to close out the position at all. The option simply expires, and when it does, there are no commissions involved in the closing of the transaction.

With writing out-of-the-money options, the chance that you will have to close out that option position may occur only 20% to 30% of the time. The other 70% or so of the time, the options that you write will expire with no exit commission costs.

3. Out-of-the-Money Spreads
The next most attractive strategy from a commission standpoint is the out-of-the-money spread.

For example, far-out-of-the-money index credit spreads will expire 80% to 90% of the time. Therefore, there will usually be only two commissions incurred to enter, but none to exit the position.

Out-of-the-money debit spreads tend to expire 65% or more of the time, and therefore, usually you will only incur two commissions instead of four (two commission to enter and two to exit).

4. Naked Strangles
The next cheapest strategy with regard to commission costs per dollar invested is writing a naked strangle (a strangle consists of a call and put with different strike prices, but with the same maturity and underlying asset), where both the naked call and the naked put are out of the money.

Here again, your only commission costs are the costs of moving into both positions. The odds are in your favor that one or both options will expire, and you will not be forced to close out your positions by buying back the options, thereby avoiding additional commissions.

5. Covered Options Writing
The final ranking strategy is a conservative one: Covered options writing.

This strategy will normally generate small commission costs if you hang onto your pivotal common stocks and are not active in buying and selling common stocks to use as the merchandise in your covered option writing program.

By avoiding excessive trading of both options and common stock when writing covered options, you will greatly reduce the commission costs per dollar invested.

By Ken Trester, Editor, MaximumOptions.com

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