Definition
The term transaction cost refers to the charges associated with the execution of a trade and the maintenance of a position. Transaction costs include brokerage commissions, exchange fees, as well as fees levied by the Securities and Exchange Commission.
Explanation
Before placing an order to buy or sell an option, an investor must understand the transaction costs associated with establishing and maintaining the position. In addition to the premiums paid or received when buying or writing an option, transaction costs affect the profitability of the investor's trade. Examples of transaction costs include:
Commissions paid to brokerage firms, typically paid on a per option basis. These fees pay for the firm's services, such as executing the order.
Exchange fees, which compensate markets such as the Chicago Board of Trade for operating a robust and reliable marketplace.
Regulatory fees, such as those charged by the Securities and Exchange Commission.
Margin interest, which applies when an investor wishes to use leverage to complete a transaction. Margin interest is the fee charged for borrowing money from the brokerage firm.
When calculating a breakeven point, the investor needs to consider the following variables: the strike price on the option, the premium paid when entering into the agreement, and the transaction costs collected by their brokerage firm.
Related Terms
underlying asset, trading pit, tick size, adjusted futures price
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