Reduce Your Commission Costs

In almost any sport, there are admission fees and expenses that must be paid to play the game. In the options game, these expenses are high. In fact, the commission costs are one of the major criticisms of trading.

A moderately active options portfolio will generate from 10% to 30% of the value of that portfolio in the form of commissions per year. In other words, if you have a $10,000 options portfolio, at the end of your first year of trading, you may incur commission costs running from $1,000 to $3,000. So, if you do not earn more than $1,000 in that account, you lose.

However, there are ways to avoid and reduce high commission costs, and means of instituting defenses to protect yourself against them.

#1 Avoid Excessive Trading

Remember, options portfolios have a high propensity for trading activity, even the most conservative ones. As you get in the game, you may become overzealous and do far more trading in your account than you should, and this will be costly. The more trading you do, the more your costs will increase.

Attempt at all times to avoid excessive activity. Stay away from strategies that require a lot of activity. And when you finish one strategy, attempt to use some of the same positions in the old strategy to create a new one. This will reduce some of the activity that is required and, thus, your commission costs.

#2 Plan for Commissions

Before you enter a strategy, build your commission costs into the profit and loss picture of that strategy. Do not assume that they will be a certain percentage of your profit. If you have two roundtrip commissions that could be incurred in a strategy, build them in before you ever enter it.

Mapping out your costs will greatly aid in your selection process, and it will direct you toward strategies that have higher profits because of much lower commission costs.

#3 Beware of the Overzealous Broker

Brokers have a tendency to ignore, or factor out, commission costs, especially when they are recommending strategies to their customers. Your broker may not be aware of commission costs, but you had better be.

When your options specialist makes a recommendation to move into a strategy, check out the commission costs first. Then you should make the decision, incorporating those commissions into your profit-loss scenario.

#4 Get a Quantity Discount

As in any other business, the more options you buy or sell, the lower the price that you will pay for each option. Using this principle, attempt to move into strategies where you are buying and selling a larger quantity of options. This will reduce the commission cost per option contract (one options contract controls 100 shares of the underlying stock), significantly in many cases. The option player who comes into the game with a small amount of capital and only buys or sells one contract is taking on huge commissions. In order to reduce that cost, buy and sell in quantity, and pay a low minimum.

I strongly suggest that you always work with at least five options when you move in and out of positions. This way you'll reduce commission costs down to one-fifth or less per option. The ideal number is 10 -- if you can get to a working level of 10 options for each strategy, then you will have attained a nominal commission cost level.

#5 Select Your Broker Carefully

We are in an era of competitive commission rates; every brokerage charges different commissions, so you want to do some research to find those that will charge the lowest commissions for the number of services that you receive.

A warning here: Do not forsake a competent options specialist for a 5% or 10% difference in commissions. If you do, you may find that you pay the difference for that many times over in the long run.

#6 Select the Cheapest Strategies

To control your commission costs, you should attempt to select strategies that incur the smallest commission costs per dollar invested. The ideal strategies are the simplest. They are (beginning with the most attractive from a commission point standpoint and following in descending order):

  • Buying call options and put options
  • Writing naked options
  • Out-of-the-money spreads
  • Naked strangles
  • Covered options writing
  • Ratio hedges
  • Ratio spreads
  • In-the-money spreads
  • Butterfly spreads

#7 Avoid Exercise (Assignment)

Exercise costs money. It costs commissions, and when you have an assignment, you may be shocked at the commission costs involved. By avoiding assignment, you avoid commission costs.

#8 Let Options Expire

When you are an option writer, the name of the game is to write an option and let it die. Let it pass on, thereby incurring only one commission -- the commission to move into the position.

One caution here: In many cases, an option will become almost worthless long before it expires. In these situations, it is best to cover your positions and use your money wisely in other areas. Whenever you write naked options, there are margin requirements that must be put up, and if you are letting that money sit because you are holding a naked option, you are wasting the use of that money.

In addition, when you are writing an option, there is a theoretical risk, and you don't want to continue to hold that risk for just one-sixteenth or one-eighth. So, although it is wise to let your option expire, should they become almost worthless before their life comes to an end, go ahead and take profits, cover those positions, and put your money to use in some other option strategy.