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Why Options Traders May Tolerate High Transaction Costs

Article Quant Q&A · Author: yong
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Summary

The document considers why traders use options when commissions can consume a noticeable share of a low-priced contract, and why some index options may appear cheaper per unit of risk than alternatives. It raises the concern that multi-leg strategies and volatility trading could be uneconomic once trading costs are included.

The response offers a market-structure explanation: volatility trading is largely institutional, and exchange members may avoid ordinary broker commissions. It also notes that exchange-related data or transaction fees can still add up. A comparison with real estate illustrates that high transaction costs do not necessarily prevent an asset class from attracting substantial trading. The discussion is brief and anecdotal; it does not quantify total option execution costs, compare specific strategies, or show that retail trades remain profitable after spreads, fees, and slippage. Its explanation therefore addresses who may trade volatility and why commissions alone do not settle the question.

Key ideas

  • Broker commissions can be a substantial fraction of the premium on inexpensive options.
  • Multi-leg option positions can accumulate costs across their component contracts.
  • Institutional participants with exchange access may face different commission economics from ordinary brokerage customers.
  • Commissions alone do not determine whether an asset attracts trading, but the response does not establish strategy profitability after all costs.

Tags

OptionsVolatilityExecutionMarket microstructure
Full text
# Transaction costs on option trades


# Transaction costs on option trades












It looks like the commissions alone for a non-index option trade is around 2-5%. For example, a BAC June ATM Call is currently trading at \$0.20; Interactive Brokers charges $0.7 per contract, which means that the commission alone is 3.5% of the value of the option! If one were to trade a more complicated strategy such as an Iron Condor to limit risk, the commission will go up even further. Yet BAC is the second most traded single-stock option! But why would anyone trade it?

Similarly, SPX options have ~10x less commissions than SPY options per unit of risk, so why trade SPY options? I'm also puzzled by the lack of index options on things like gold. (Only a month ago did index options on non-US indices launch). Do investors primarily "buy-and-hold" options using strategies like call-writing?

It seems that any sort of "clever" strategy that trades volatility as an asset class faces incredible transaction costs. Is it simply not done?

## Answer by baerrus (score 2)

https://quant.stackexchange.com/a/18138

Volatility is mostly an "institutional" trade. People who trade it have a seat on one of the exchanges so they do not pay broker commissions. On top OPRA still imposes its own fees, which can add up. In regards of why anyone would trade an asset when transaction costs are 3-5%. Ask millions of people who flip real estate - transaction costs are 5% and up. Yet real estate is the most popular trade in the world :)

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.