Not so long ago, I mentioned the time when I used to day or swing trade, back in the horse-and-buggy days. I typically paid for as much delta as I could afford when I bought a long call or put in those days. I wanted the absolute value of the delta to be 70 or above, or 0.70 or above without the 100 multiplier applied.

In other words, if I were buying a long call because I thought the underlying was heading higher, I wanted a call with a delta between 70 and 100. If I was buying a long put because I thought the underlying was heading lower, I wanted a put with a delta between -70 and -100. This meant that these options were in the money, and they had intrinsic value--the amount by which they were in the money--as well as extrinsic value.

Why did I do that? Options decay, and their values change with changes in implied volatility. Of course, options don't decay much over the course of a day, unless one is buying them close to expiration, but I often did trade during expiration week. I couldn't control those inputs into an option's price. I wanted to be sure that the option's price would benefit enough from the underlying's movement to overcome any possible adverse effects from the passage of time or changes in implied volatility.

In addition, decay and changes in implied volatility don't impact the intrinsic part of an option's value. Buying options with intrinsic value helped insulate my long call or put from adverse effects related to decay and changes in IV, two inputs into an option's price.

I mentioned in that previous article that I'd begun that practice after reading Lawrence G. McMillan's Options as a Strategic Investment early in my options-trading career. Not too long ago, when conversing with a subscriber, I rechecked what McMillan had to say. His exact advice? Choose an option with a delta of 100!

Rereading McMillan's advice about day or swing trading with options reminded me of another reason it's important that options prices move as much in lockstep with the underlying as possible, that the day trader buy as much delta as possible. I'll let McMillan tell you why. "What makes options difficult in such a short-term situation is their relatively wide bid-ask spread, as compared to that of the underlying instrument," McMillan warned (102).

Bid/Ask Spread for PFE Stock and PFE Options:

Across the top, we see the bid/ask spread for the underlying PFE stock. That spread is a penny, so buying 100 shares of stock at the ask and selling at the bid is not going to result in too much slippage. If the stock has moved higher by enough to pay for the commissions, the day or swing trader employing PFE stock doesn't have to worry much about slippage.

What if one is buying a call option with a delta of .70 (or 70 after the multiplier is applied) or above? That would mean buying the May14 28 Call with the delta of 0.78. That call has a bid/ask spread of 2.01-1.79 = 0.22. I don't trade PFE options, so I have no idea if it's often possible to trade these options exactly at the mark or the mid-price between the bid and the ask. If they're highly liquid and if the market is not particularly chaotic, it may be possible to do so, but a $0.22 spread between the bid and the ask certainly opens up a lot more opportunity for slippage to be incurred. Remember that a 100 multiplier must be applied. If a number of contracts are sold, that slippage can add up rapidly. Of course, the bid/ask spread widens the deeper that option is in the money, with the bid/ask spread for the May14 23 call with the delta at 0.90 being $0.50.

Without adding in the slippage, let's run some comparisons for the changes in value related to a one-standard deviation move for PFE. On the day this chart was snapped, a one-standard deviation move for PFE was only $0.29.

Theoretical Price-related Change in Value with a One-Standard Deviation Move:

May14 28 Call: .78 x $0.29 x 100 multiplier = $22.62
May14 23 Call: .90 x $0.29 x 100 multiplier = $26.10

We see McMillan's point about the higher delta option providing more opportunity to capitalize on a beneficial move in the underlying. However, the point about the wide bid/ask spread complications matters, too, doesn't it, unless one is fairly certain that trades can be filled at the mid-price or mark? The wider bid/ask spread in the deeper-in-the-money option provides even more opportunity for slippage, doesn't it, particularly if those options aren't as liquid as the closer-to-the-money options? I don't know, Larry McMillan. I would have to investigate my chosen vehicle further before I decided I need to buy a more than 70-80 deltas. Be warned that I'm not currently day or swing trading, so I'm suggesting things you might be thinking about, not asserting that my conclusions are the correct ones. There is no substitute for current experience with these trades.

The bottom line? First, the glaring one that hasn't yet been mentioned: PFE is probably not a great vehicle for day or swing trading. A one-standard-deviation move was just too small to make this a great vehicle for this type of trade, at least at the time these charts were snapped.

Next, should the bid/ask spread in an underlying's options concern you when you're considering whether to employ that security's options for day or swing trading? Certainly. However, it's probably just as important that you know about the liquidity in those options. What's the volume and the open interest? Compare that to the volume and open interest of a security that you know to be highly liquid, such as AAPL or IWM options. Not many securities' options will have the volume and open interest of a popular momentum stock or ETF, but at least establish some benchmark. Trading options in a highly liquid vehicle with a slightly wider bid/ask spread still might incur less slippage than a less heavily traded vehicle with a narrower bid/ask spread. Of course, be aware that a vehicle's liquidity can change rapidly in adverse market conditions.

Before you throw down too much money day or swing trading a security via long calls or puts, try the positions in small sizes. Are you able to buy and sell near the mark or mid-price between options? Are you able to do that during the quiet lunchtime period? What about when the underlying is dropping fast? Can you make any deductions about what would happen during low-volume holiday or summertime periods?

The further away from the mark you have to go to buy or sell, the more important the width of that bid/ask spread is going to be and the more difficult it's going to be to make money day or swing trading that security's options. Perhaps consider how much that security typically moves during the day. Will that move be enough to make up the slippage when you have to buy nearer the ask and sell nearer the bid?

As McMillan warned, you're likely not going to make money day or swing trading low-priced options with low deltas unless the move is huge, much larger than the typical movement for that underlying. Then, you'll make money and a higher percentage profit than you would with the higher-delta options. It is possible during certain market conditions to make money that way: many do. They just also tend to lose money when their guesses about the strength or timing of an underlying's move are wrong, even if the underlying moves in the right direction. It's most disheartening to see the underlying moving in the direction you picked, but the value of your long option declining anyway because of the timing of the move or IV changes.

That leads to one more warning: Day trading is hard and requires you to employ strict discipline, although a few great weeks of day trading can fool you into thinking it's easy. I know lots of people who make lots of money day or swing trading. For a time. I don't know many who make money over the long term that way, though. Learning to buy and sell options, to set max losses and trust yourself to adhere to them, to set contingent or OCO orders that help you take the emotion out of the process all will benefit your trading, whether or not you find your stride in day trading or use the process as a jumping-off point to other types of options trades. Just don't, as some have done, bet too much on your day trades and ratchet up those bets when you start losing money, to make up what you lost. That's the way to ruin.

Linda Piazza