Options Trading¶
The following are useful introductions to trading options:
Nine Questions Every ETF Investor Should Ask Before Investing
The Role and Activities of Authorized Participants of Exchange-Traded Funds
Buying and selling options is a safe way to earn a steady income of premiums. However, the weekly gain is approximately 2% - 5% of the amount invested. A high-risk high-reward strategy is trading naked options, but it could be very risky depending on the situation.
Daily options trading is another strategy to increase the gains for the same amount of investments. There are many indicators, but the ones I find easy to understand and use are
Moving Average Convergence/Divergence Oscillator (MACD),
Money Flow Index (MFI),
Volatility Index (VIX), and
Time and Sales Window (Tape Reading).
The following are insightful forum resources I have come across
Limit and stop-limit orders should be the default order types.
LEAPS are evil: institutional money do not trade LEAPS. A rule of thumb is to never buy more than 150 days of time. Try to gauge how much time you think you need and do buy a little extra for wiggle room. However, it is often more profitable to buy less time and more contracts.
realjumper posted some
tips on using Heikin-Ashicharts.Yasuji Yamanaka laid out the
five rules of Heikin-Ashi.Rin0 offers some interesting
insights into tape readingandday trading.
Margin trading is another tool available to investors; however, the fees involved (varies among brokerages) limits this to sure-fire situations. Note that margins in forex is an entirely different concept.
Brokerages use four terms to describe option orders: sell-to-open, buy-to-close, buy-to-open, and sell-to-close. While it may seem odd that you would buy to close a position, by taking a long position in the option, you neutralize the rights you sold when you wrote the option with the rights gained when you buy the new options, which closes your position.
To start your journey, I recommend checking out tastyworks, the successor to TD Ameritrade’s thinkorswim, as your first brokerage. finviz and TradingView are sufficient as market monitors. If you’re only interested in long-term investments, go with either Vanguard’s index funds or Robinhood. For high-frequency algorithmic trading, go with Interactive Brokers.
Taxation¶
Some final issues to worry about are taxes specifically Schedule D, 8949, and 1099-B. Brokerages send out the 1099-B at tax time, which you then use to fill out the 8949 and Schedule D. Make sure you adjust your cost basis before filling out these forms. Things that affect the cost basis are
One of the confusing points about the 8949 with respect to options are the acquired and disposed dates. The acquired date is the date you closed the transaction. The disposed date is when the transaction settled. For option short sales with a loss, the disposed date is one business day after the acquired date. However, if you have a gain, then the disposed date is equal to the acquired date. If your option expires, the acquired date is the date of expiry. Brokerages typically report these dates correctly, but it’s good to verify as you’re filling out your taxes.
Unless the consolidated 1099-B form is wrong, you can just report those short and long term gains or losses. These capital gains are taxed by the federal government. If you live in multiple states, then you need to apportion how much of your capital gains goes to which state.
When trading ETFs, avoid ones that are limited partnerships unless you want to process an additional Schedule K-1 tax form. While ETF options are taxed like regular stocks, ETF shares have different tax implications. If an ETF does not issue a K-1, then commission fees are the only cost to minimize because expense ratios are built into the NAV. However, a lower expense ratio is always a good thing.
One more annoying issue to be aware of is the adjusted cost basis for ESPP and RSUs. Companies will typically withhold a few shares to cover the taxes, so you will be double taxed on the stock discount you received if you report the cost basis issued to you. What you need to do is to fill it out as usual, but do an adjustment saying that the cost basis is wrong. Then fill in the adjusted cost basis that your brokerage has on their website. The brokerage already reported the proceeds to the IRS, but they did not include the adjusted cost basis.
On a final investment note, after maxing out on your Roth 401(k), consider making use of the backdoor Roth IRA. Furthermore, either select a target fund or understand portfolio rebalancing [JKZ10][Dar08].
References