Can You Prop Trade Options?

Many new traders ask “can you trade options in a prop trading account?”

The answer is yes.

You can trade options in a prop trading account. But just because you can trade options inside a prop trading account does not mean you should.  Since prop traders can access significant leverage, in some situations, equities and ETFs may make more sense than options, which suffer from time decay, inferior liquidity, and lack of access to extended hours trading. 

Before we get into more detail, we are not saying equities are better than options, or vice versa. They are simply tools.

The Dream of Too Many Options Traders

Many traders want to take $10,000, leverage it up 20 times in a prop account, and put it all on a call options position. 

And if they’re right, maybe they’ll turn that $10,000 into $1,000,000.

Well, we’re here to tell you that is most likely not going to happen. And if you are looking to strike it rich on a single trade, you are probably not a good fit for a prop trading career.

But let’s talk about some of the differences between equities and options in a prop situation.

Equities vs. Options in Prop Trading

For many traders, the primary attraction of options is the leverage — at least when it comes to speculating on a stock, index, or ETF’s direction.

As of the time we’re writing this, Disney (DIS) is trading at $177.30. So you can buy 100 shares for a total of $17,730.

Or, you could buy a $175 call option expiring in 52 days for $10, or $1,000 in cash terms.

The option gave you exposure to 100 shares of Disney at just 5.6% of the cost of the stock. ($1,000/$17,730).

However, the option has several problems.

1. Theta/Time Decay

The first issue with options is theta, or time decay.

All things being equal, long options positions lose value as time passes because the time premium embedded in the options erodes away.

Assume Disney goes flat for 15 days.

If you were long the stock for 15 days without any movement, you’re not going to celebrate. But at least you’re not down money. You can get out and put on another position.

But let’s say you took that call option. It would be worth about $8, a loss of 20%*. Just because time passed. 

And what if the stock dropped just $2.30 to $175 in that same 15 day period? The option would be worth about $6.70 for a 33% loss*.

On a leveraged options position, a 33% loss could mean a significant hit to your capital base.

And remember, even if the stock moves in your direction, if that movement is too slow, you can still lose money on the options.

*based on the Options Industry Council’s options calculator

2. The Liquidity Challenge

Options are much less liquid than stocks, even when it comes to the biggest names like Apple (AAPL) and Tesla (TSLA).

Let’s look at spreads.

Apple stock, for example, typically trades with a 1 cent spread between the bid and ask. That’s a spread of about 0.008% at the current price of $131.59.

Meanwhile, look at the Apple call options chain below. Many of these options have a spread of 5 cents, which can be 2% or more.

And that’s for Apple — an incredibly liquid stock. What about something a little more on the wild side, like Riot Blockchain (RIOT)? RIOT’s stock is trading with a 5 cent spread, which isn’t exactly ideal as it is.

Many of these options have 20-40 cent spreads!

Yes, you can get filled in the middle, but you can’t always count on an optimal execution.

And when markets are in crisis mode, getting good fills on options positions is even tougher — whether you’re dealing with a giant like Apple or a more volatile name like Riot Blockchain.

3. Extended Hours Trading?

Equities also have extended hours trading. How many times have you seen a stock scream higher after the close only to collapse before the open? It happens all the time with earnings reports and other big news.

At T3 Trading Group, you can trade a stock at any time between 4:00 a.m. and 8:00 p.m. ET.

With options, you’re completely shut out of that extended hours trading session.

Here’s a Tesla chart showing the stock pre-market (left side) and after the open (right side).

If you came into the morning long the stock and wanted to get out, you could just sell it premarket.

If you were long call options and wanted to get out, you’d have two imperfect options:

1. Wait for the open
2. Short the stock against the long call options position

With option #1, you’d simply be hoping for the best — which is NEVER an ideal strategy in trading.

And with option #2, you’re now managing two positions instead of one, and adding a great deal of complexity because you’ll have to take into account issues like the delta of the particular options you hold. That adds a lot of complexity to your morning!

If you’d just been in the stock, you could just close out the position and move on to the next trade if you wished.

Don’t Forget Leveraged ETFs

Prop traders can trade leveraged ETFs.

Many prop traders get long or short leveraged ETFs like TZA (triple short Russell 2000) and TQQQ (triple short Nasdaq 100) to add even more upside potential (and of course, downside risk) to their portfolios.

This gives a ‘leverage on leverage’ impact to one’s portfolio while retaining the advantages of equity trading like liquidity and time flexibility.

Should Prop Traders Avoid Options?

By this point, you’re probably asking “so are options bad for prop trading?”

The answer is… NO! There is nothing inherently wrong with options. They are just another tool.

Many of our licensed prop traders use options — particularly to define the risk on a particular position, or as part of a multi-asset or quantitative strategy. 

Plus, certain options strategies like straddles, straddle, calendar spreads, and butterflies have no equity equivalent. 

But remember, we are talking about prop trading accounts, which give equity traders leverage, which is a major advantage of options trading.

When your equities account is leveraged 8-20 times, you often have all the leverage you’d ever need. Plus you get the additional advantages of equities you just learned about, which are liquidity, flexibility, and simplicity. 

Yes, options have an undeniable sex appeal that attracts many traders. 

But when it comes to making purely directional trades on stock or ETFs inside a prop account, equities are often superior to options.

Interested in learning more about trading with T3? Click here to get in touch.

We can talk about equities, options, or anything else that’s on your mind!