What is Options Trading?
Before we get into options trading, let’s see what a stock option is. So, what is an option? An option is a contract that you can purchase. It’s a ‘derivative’ that derives its value from underlying securities such as ETFs and stocks (read about ETFs vs stock picking). A Stock Option gives you the right to buy or sell stock at an agreed price on or before a particular date.
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Types of Stock Options
Primarily, there are two types of options – Call Options and Put Options.
What is a Call Option?
With the call option, the holder gets the right (but not the obligation) to purchase shares at an agreed-upon price on or before the expiration date.
What is a Put Option?
With the put option, the holder gets the right (but not the obligation) to sell the shares at an agreed-upon price on or before the expiration date.
To sum it up, both types of stock options can be used to bet on price movements in opposite direction. But, there are multiple combinations of buy & sell call and put options that can be leveraged to maximize chances of gains and limit investor’s risks. Options trading is the act of transacting stock options to make financial gains and limit the risk exposure at the same time.
Where to Learn Options Trading?
Let’s discuss where to learn options trading and how long it takes for an average person to learn options trading. In industry, the average amount of time required for a newbie investor to reach the junior trader level of options trading is 6 months to two years. Everyone has their own speed, but one must make sure to fully understand the risks of options trading before even putting a cent into options trading.
You can learn options trading from articles like this one. There are many courses on the internet from which you can learn- both paid and free. On our website, we have attempted to cover all aspects of options in an easy to understand manner. You can also gather a reasonable amount of information to step into options trading from Youtube. YouTube is home to multiple experts who post informative videos regarding options trading with live examples.
Why have an Options Trading Strategy?
People purchase stocks in the hope of getting positive returns on their investments. They decide whether they want to day trade it, swing it or hold it long-term. You can hold a stock forever, but ideally, you would want to sell it for a profit. Now, the downside is when the market goes down or sideways, you don’t make money, plus you lose your money when the stock falls.
Generally, you can’t make money with stocks when the market goes down or trade sideways. That is where options come in. Options allow you to make money in any market condition – whether the market goes up, down, or sideways. You can make money in any situation in options by leveraging different strategies.
Options trading offers many advantages if you learn the tricks of the trade. One of the main benefits of options trading is that it lets you commit less capital than purchasing stocks directly.
How to Start Trading Stock Options?
To start trading, you must meet the requirements. You must be approved for options trading through your broker. The broker will ask to fill out a questionnaire. The questions will be about your investing experience, financial status, and knowledge of trading options. Some brokers will NOT allow you access to options trading if they believe you are not knowledgeable enough about risks of investing. We believe this is very good guardrail in place as it prevents you from making an uninformed decision and losing your money.
Why is Trading Stock Options Risky?
Options trading carries asymmetric risk. While the gains are accelerated, the losses can be accelerated too. In case of a worthless options expiration, the investor (option buyer) loses all the premium paid for it, losing the entire capital!
There is a limited time frame for the investment to play out in your favor. The options traders need to take advantage of relative price movement within the contract timeframe, i.e. before the expiration date. This requires speculating – deciding when to buy, sell, exercise, or let the option expire.
Options trading is considered risky mostly because of the leveraged capital loss. Some strategies are considered risky because of the complexity involved with them. Due to time difference across borders, international trading options have additional risks.
To avoid letting beginner investors make unintentional mistakes with options, brokerages categorize the investors in different levels. Read about Levels in Options Trading.
When to Buy or Sell Call Options?
The chart below gives a general idea when you might want to either buy or sell a call option.
Buy Call Option
When you BUY a Call Option, you pay a premium to buy the contract.
You believe the stock price will go UP, higher than your breakeven price, at some point before the expiration date.
Favorable Result: Stock Price > Breakeven Price
- You can buy and hold the 100 shares
- You can sell the call option contract for a profit
Unfavorable Result: Stock Price < Strike Price
You lose all the premium you paid.
Sell Call Option
When you WRITE or SELL a Call Option, you earn a premium for selling the contract.
You believe the stock price will NOT go higher than the breakeven price OR you are content with gains up to the breakeven price.
Favorable Result: Stock Price < Strike Price of Call
You keep all the premium and all your 100 shares.
Unfavorable Result: Stock Price >> Breakeven Price
The stock skyrockets and you must settle for limited gains.
When to Buy or Sell Put Options?
The chart below gives a general idea when you might want to either buy or sell a put option.
Buy Put Option
When you BUY a Put Option, you pay a premium to buy the contract.
You believe the stock price will go DOWN, lower than your breakeven price, at some point before the expiration date.
Favorable Result: Stock Price < Breakeven Price
You can buy shares at lower prices and sell them at strike price
You can sell the put option contract for a profit
Unfavorable Result: Stock Price > Strike Price
You lose all the premium you paid.
Sell Put Option
When you WRITE or SELL a Put Option, you earn a premium for selling the contract.
You believe the stock price will NOT go lower than the breakeven price OR you are content with buying 100 shares at breakeven price.
Favorable Result: Stock Price > Strike Price of Put
You keep all the premium.
Unfavorable Result: Stock Price < Breakeven Price
The stock plummets a lot lower than your breakeven price and you must buy 100 shares at strike price.
Where can I Buy and Sell Stock Options?
Most stock brokers allow qualified investors, based on the questionnaire as mentioned above, to trade options. Even on newer platforms such as Robinhood and Webull, investors can start with stock options for low or no fees. The legacy brokerages might have better analytics and features, with quick trade execution times, but beginners and intermediates will find the newer brokers a good fit for their needs.
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- The Greeks: Delta and Gamma of a Stock Option
- Stock Order Types
- Levels In Options Trading