It is quite possible that the adage, “The early bird gets the worm,” may not always apply to day traders. Trading options is a popular activity because options can reduce your financial risk when buying and selling stocks. However, it is a complicated task, and whether the option is more or less expensive at a particular time of day may not be the best question.
Options are sometimes more expensive in the morning. However, successful traders pay less attention to the time of day the options are executed and give more attention to the option’s expiration date, the Greeks, and volatility, both implied and historical.
The rest of this article will explain a few concepts related to this question in detail, including a brief review of terms, an explanation of the 10 A.M. rule, and why purchase timing matters less than volatility.
Basic Concepts of Options Trading
Stock options are popular today because even average investors with a basic knowledge of how options and the stock market work often make significant money and then boast their success stories to friends and social media. Then, trendy discussion forums like Quora and Reddit keep those success conversations alive.
While it is true that not everyone does well, those who are successful are often very successful. And one thing these people have in common is that they fully understand the basics of options trading, and they skillfully use their understanding to boost income and hedge losses.
To review, the most important concept that beginners need to understand that options are not stock. Options give you the right to buy or sell shares of stock at a specific price by a certain date, which is why volatility is a good thing for options trading.
Options are enticing because they give you leverage. However, the key to success when buying and selling options is to be aware of the relationship between the stock price, contract price, the option’s strike price, the option’s expiration date, and volatility without being overly concerned with the time of day in which you are making the purchase.
After considering the price, timing and volatility become the difference between profit and loss.
The vocabulary can get confusing, so here is a list of basic terms to understand.
- In the Money (ITM): This option contract still has intrinsic value because the stock is selling at a higher price than the option’s strike price.
- Out of the Money (OTM): This option has no intrinsic value because the stock is selling at a higher price than the option’s strike price.
- At the Money (ATM): This option has an intrinsic value of zero.
- Implied Volatility: An estimation of how likely the market thinks the stock price will move.
- Historical Volatility: A measurement of how far a stock’s price moves away from its average value.
An Explanation of the 10 A.M. Rule
It does not take long for beginner traders to learn that stock and option prices are generally higher when markets open but then reverse.
This reversal is why many advisers follow the 10 A.M. rule based on the belief that if stock prices are high at that point in the day, the stock is likely to gain momentum.
The most active time in the stock market is from 9:30 to 11:30, and since day-trading is a short-term venture, 10 o’clock seems to be the “sweet spot” for gauging if the stock will gap up or gap down. Investopedia defines gapping as when “the price of the stock opens far above or below the previous day’s close with no trading in between.”
News headlines, world occurrences, and public health impact markets overnight–and throughout the day. However, generally speaking, stock prices often rise early, only to fall after stop orders get executed. Stop orders are orders to buy or sell a stock when the price fluctuates beyond a certain point to limit loss for the investor.
The reverse is also true. Stocks can fall overnight only to rally later in the day.
Why People Trade As Soon as the Market Opens?
Sometimes, options are more expensive in the morning hours because everything that happens after markets close impacts the opening price. Therefore, most individual traders respond to those events in the beginning moments of the market, which is also when trading volume is at its peak.
Because volume provides much information about patterns, many traders believe that the best time to buy or sell is soon after the market’s opening bell, but successful trading is never that simple. If it was, markets could close at noon each day.
Remember, traders are not interacting with stocks when buying and selling options but instead with each stock’s potential price change and volatility. So, while the opening bell is when most activity happens, many traders believe the answer to the question, is it more expensive to trade options in the morning, is yes. However, the accurate answer is a resounding, “It depends.”
The Worst Time To Trade
Although options will not necessarily be more or less expensive because of the time of day, there are times when it makes less sense to trade.
For example, human behavior is predictable. We get hungry midday, so most people take a lunch break between 11:30 and 1:00, which obviously slows market activity. This reduced activity means volatility will be lower during this time of day. Therefore, it seldom makes sense to trade options during lunch hour.
The Truth About Option Pricing
Even considering the lunch hour, though, it is impossible to definitively answer if options are more expensive in the morning, or at any other time of day, for that matter.
Navigation Trading has a video on YouTube that explains this process of determining an option’s price and value in detail:
You can watch it at the link above, but it comes down to comparing options to themselves using an implied volatility tool, like the one at Ivolatility. The company’s basic plan is free and gives you access to many popular tools with the option of upgrading your account when you see the benefits it can provide.
However, the point to remember is the higher the implied volatility, the more expensive the option price, regardless of the time of day you’re looking to purchase the option.
But expensive does not mean traders should not buy the option. In fact, if traders take the time to complete the calculations, they may realize that some expensive options are highly profitable.
Note that the option’s price means nothing without factoring in the Greeks and implied and historical volatility. This oversight is how people can lose money in options even when stock prices go up.
The way to win is not to concern yourself with whether the option is cheap or expensive, and you should not be overly concerned with the time of day the option is purchased. Rather, you should consider the option’s implied and historical volatility.
Trading options is both fun and entertaining and can make you a sizable profit when done correctly, but it can also produce a significant loss when traders fail to look at the total picture.
It is a common observation that option prices are higher in the morning.
However, to become a successful trader, you should not focus on the option or even the stock’s price but on its volatility. Profits come from movement, not from the time of day an option is purchased or sold.