No one I know likes to pay commissions. Except me. When I pay a commission on the sale of an option, I know that in most cases, I will recover that commission cost in less than one day. How is that possible? Read on.
All stock options trading commission costs are not equal. I'm not talking about the difference between full-service broker commissions (which may go into the hundreds of dollars) with a discount broker's rate, however. Comparing those kinds of commissions is at least an apples-to-apples comparison.
No, I'm talking about the significance of the commission you pay when you buy stock or a mutual fund and when you sell an option. If you bought 100 shares of a $50 stock, you would shell out $5,000 plus about a $10 commission at your favorite discount broker. The only thing you know for certain about this purchase is that it ties up $5,010 that could be earning interest in a savings account.
A year later, unless the stock has increased in value, you still would not have covered the money you paid out for the commission. Even though the commission works out to only 0.2% of the total investment, it is no wonder that commissions are a concern for the stock trader.
Contrast the stock purchase to the sale of a single option for $1.50 (a one-month at-the-money call or put option on SPY could be sold for almost double this amount, but let's take the lower number). On the $150 sale, Terry's Tips subscribers at thinkorswim would pay a commission of $1.50. This works out to 1% of the purchase price, or 5 times the percentage you would have paid to buy the stock.
However, the option seller has sold a depreciating asset that goes down in value every day. Over the course of the next month, the time premium of the option that was sold for $150 will depreciate by an average of $3 per day. In other words, one day after selling the option, if the stock price doesn't change, the commission cost will have been totally recovered two times over.
Of course, if a call was sold and the stock went up, the option that was sold for $1.50 might cost more to buy back the next day, but the option-seller presumably owns an off-setting longer-term call that will also increase in value. But the bottom line is the same - every single day of the short option's life, the entire commission cost will be more than covered by the decay of the option.
The buyer of stock might have to wait a year or more for the stock to go up and finally cover his commission cost while the option seller will cover his commission cost before lunch-time the following day.
In his mind, the option-seller should think of the commission cost as evidence that he has made a good investment that will pay for itself in less than a day. The more commissions you pay, the more decay you will be collecting.
This is just another example that the world of stock trading is far different from the world of stock options trading. While it may take a year to recover the commission you pay on a stock purchase, you would be disappointed if it took an entire day to recover that cost if you sold an option.
Overbought/Oversold for September 1, 2008
Major Benchmarks"In the past, I have spent a lot of money and time being tutored on trading options. None of these courses came close to explaining how to manipulate and adjust the given strategy as you have so expertly done in your 10K Strategy literature. What I liked about your approach is that you've managed to explain your strategy in terms that the layman can understand."
--- Paul D.
Terrys Tips has been providing stock options trading services since 2002.