In our continued discussion about picking a broker for your options trading, one must always consider commissions. As discussed in our previous article, the good news is that rates are more competitive than at any other time. When you are just starting out learning how to trade options there are many brokers to choose from and just as many different commission structures to figure out. We will discuss some of the differences to help you zero in on what may work best for you.
When we talk about commissions for options trading, the discussion can get a little complex. Here for example are three different structures:
1) $9.99 + $.75 per option contract. In this pricing scenario one option would cost $9.99 + $.75 = $10.74. 10 contracts would cost $9.99 + (10 x .75 ) = $17.49
2) $12.50 minimum or $.50 / contract. So for one option the cost would be $12.50. For 10 options the price is still $12.50. Even 20 options = $12.50
3) $2.50 per contract. One option would cost $2.50 and 10 options would cost $25.00.
So which of these is the best commission for a new options trader? Well, it depends. At first glance it might appear that the second choice is the best. However, this might not always be the case. First we have to look at what is most likely to happen during the entire trade from open to close.
It is very common that during the life of your options trade that you will be faced with making some type of adjustment. What does that mean? It means that you will need to make a change to your position and close some of the position and/or open new ones. As you will come to see when you gain more experience as an options trader, adjusting open positions is common.
But let’s just take a quick and simple example to make the point. Say we buy eight options. The cost based on number two pricing would = $12.50 and the cost using number 3 would = $20. So let’s say you want to add one more option during the trade for an adjustment. The cost of simply adding one additional contract using pricing number two would be $12.50 for a total investment of $25.
The cost for adding one additional contract using pricing number three would be $2.50 for a total of $22.50 total investment. So while number two appeared to be the clear winner, if we think we’re likely to adjust during the trade, pricing number three might be better!
So the lesson here is to make sure you compare commission plans based on how you trade an entire position from open to close, not based on opening the trade. This applies whether you are selling options to create income as well as if you are buying options for a directional move.
Lastly, the bigger your account size it and the amount of trading you do, the stronger your ability to negotiate with a broker. I always suggest asking for a better rate. The worst they can say is no, but you never know when they just might say yes!
Seth Freudberg and Michael Schwartz