How Large Index Options Can Help Reduce Your Commission Costs

commission costs

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This isn't a trick or secret tip by any means - but maybe you just haven't thought about commissions like this before.

You see, all of us have done the searching online for the "best" commissions. I know I still look around now and then to make sure I'm getting the best deal I can with thinkorswim (my current broker). And if I don't I let them know about it and try to negotiate my rates lower. This doesn't work all the time, but it has in the past.

What we fail to do in all this is determine up front how many contracts we are going to trade and on what security. Think about it like the Costco business model - buy/sell in bulk!

I would argue that if you are trading 5-20 contracts on a very large index, another broker might have lower commissions than if you were trading 1-5 contracts on smaller securities.

Again you have to know what kind of trader you are first before you go commission hunting. . .

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The Root Of The Problem

When we all get started trading options, we naturally trade smaller contracts. It's simple and easy to understand when the contracts are only worth between $20-50 each. I get it - and I did it before too.

Instead, we should all think about scaling our positions and looking at commissions on a higher level. Overall income from margin/investment versus the per contract basis that some get trapped into thinking about first.

In the case of trading options, indexes (SPX, RUT, NDX) and index-EFTs (SPY, DIA, QQQ, IWM) are some of the best vehicles for traders. But which do you choose? They both will trade very close to each other as far as a relative value so you might think it doesn't matter right?

Since we are taking about commissions - it DOES matter which one you choose!

Bigger Is Better For Commissions

In most cases you are going to be better off focusing on the larger index options (SPX, RUT, NDX) because they have higher contract values, limiting the number of contracts you need to trade thus reducing your commissions.

Below is a screenshot of the trade summary for 10 Short SPY April 115 Puts. We are taking in a credit of approx. $185 after the commissions to the broker because we have to sell 10 contracts of $15.00 The margin required for this trade would be $11,500.

Keep in mind that if this doesn't expire worthless and you have to exit the trade it will again cost another $15.00 in commissions to get out.

Now, here is a screenshot of the trade summary for 1 Short SPX April 1,150 Put. Notice that the commissions are only $1.50 because we are selling a single higher value contract on a larger index. The margin is nearly identical, and we are taking in virtually the same credit.

Makes you think about how you've been trading doesn't it?

8% More Premium Because Of This Tweak

This one little change brings in about 8% more premium with nearly the same margin requirement. All because you are moving to a higher index option, selling fewer contracts and saving money on commissions.

I'd love to hear what you think in the comments below. Has this worked for you before? Did you even think you could do this?

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.