An option contract gives the holder the right, but not the obligation, to buy with a “call option” or sell with a “put option” an underlying asset at a given price (called the “strike price”) up to or on a certain date (called the “expiry date”).
If you already trade a particular asset and would like to branch out into other ways of taking a view on the market, then options trading may be for you.
Table of Contents [Hide]
- Step 1: Educate Yourself About Options.
- Step 2: Connect to the Internet.
- Step 3: Select a Good Online Options Broker.
- Step 4: Open an Account.
- Step 5: Practice Trading Options.
- Step 6: Develop a Plan.
- Step 7: Fund Your Account and Go Live.
- Best Online Options Brokers
- Advantages of Trading Options
- Disadvantages of Trading Options
- Knowledge is Power in Options Trading
Step 1: Educate Yourself About Options.
Before starting to trade options, you’ll want to learn about the various options strategies you can use and their risk profiles so that you understand how options can help you encapsulate a market view. You can take an options trading course or read books on the subject to do this. You will also want to review the specifics and operational mechanics of any options contracts you plan on trading, since missing an expiration date, not knowing the amount of risk you are taking or transacting the wrong type or style of option can be a costly mistake.
Step 2: Connect to the Internet.
Since you will generally want to trade options online via a trading platform, having a relatively modern computer or mobile device connected to the internet is virtually a necessity.
Step 3: Select a Good Online Options Broker.
Many online brokers will allow you to trade options. Select a well-regulated broker that offers options on the asset classes you most want to trade along with a good options trading platform and tight dealing spreads. Since options are more advanced trading instruments, you may also need to qualify to trade options via a particular broker.
Step 4: Open an Account.
Review your chosen broker’s initial deposit requirements and account types to see what will suit you best. Also, familiarize yourself with the broker’s margin requirements for various types of options strategies so that you can have enough funds deposited in your trading account to cover the options you want to trade.
Step 5: Practice Trading Options.
Rather than jumping right into trading options with real money, it makes sense to first practice trading options in a demo account. This helps you understand the mechanics of options trading and gives you a risk-free chance to learn how to use your broker’s trading platform.
Step 6: Develop a Plan.
It’s time to develop and test one or more options trading strategies that have a decent chance of success given the risk you will be taking. You can then incorporate them into an overall trading plan that lays out how you intend to operate your options trading business and manage your risk capital.
Step 7: Fund Your Account and Go Live.
Once you have prepared yourself for trading options by following these steps, you’re ready to start trading options in a live account once you identify a suitable opportunity in the market. Always make sure you have placed enough funds on deposit with your broker as margin to support your options trading strategies and trade only with money you can afford to lose.
Best Online Options Brokers
When selecting an online options broker, keeping options trading commissions low is important to just about any trader. You also need to watch out for any hidden fees a broker charges for you to use their trading platforms or access market data.
Since your skill level, trading plan and needs will likely differ from other traders, you’ll want to select a broker that is right for you. Take into account your planned trading style, your need for educational materials and any tools you think you will need to trade options successfully.
You will also want to watch out for any unregulated online options brokers that might be trying to scam you. Check to see that a broker is overseen by a major regulatory authority before funding an account with them. Note that options brokers may also check how much experience you have before giving you permission to trade options and may set limits on your options trading activities.
To help you narrow your search, Benzinga has compiled a table below comparing some well-regulated online options brokers you can approach to trade options through.
Advantages of Trading Options
Trading options has several notable advantages over just trading the underlying asset. Some of them are discussed below.
The leverage that trading options provides can allow you to control large positions with relatively little money. If you think shares in Apple Inc. (NASDAQ: AAPL) will rise from $118, for example, you might buy a December $120 call option on 100 shares for $7 or just $700 in total. That is a considerably lower cost to take a long position in Apple than the $11,800 you would need to buy 100 shares of the stock itself.
Customized Risk Profiles
Using options lets you modify your risk profile when trading to adapt to a specific market view. For example, you can buy a call option to take a bullish view on the underlying asset while having your risk limited to the premium you initially paid.
Using the long option example in the previous section, if Apple’s stock rises to $140 by its December expiration date, then you will have made $20 less the $7 premium you paid (or $13) times 100 shares for a net profit of $1,300 on the option or $2,200 had you purchased the stock. Alternatively, if the stock ends up at $110, then you will just lose the $700 you initially paid for the option while you would have lost $800 had you instead purchased 100 shares of the stock itself.
You can also buy both a put and a call option with the same strike price (a strategy known as a “straddle”) if you expect the market to move significantly, but you are not clear on the direction and want to keep your downside risk limited.
You can use the so-called “covered write” option strategy to sell (write) options against a position in the underlying asset for additional income. For example, if you are long 100 shares of Apple stock at $118, you can sell a December $120 call option for $700.
If the market has moved above $120 by the option’s December expiration date, you can just deliver your Apple stock into the option contract when the option is exercised. Not only will you have made $2 per share or $200 on the underlying stock, but you will also have captured the $700 in option premium for a total gain of $900.
If the market instead declines, you will have the $700 you received from selling the option to buffer losses on the long stock position, giving you an improved breakeven price of $112 instead of $118.
Disadvantages of Trading Options
Although using options expands the choices traders have to express a market view, they do have a few possible disadvantages you should be aware of.
Unlike an actual asset, options contracts expire at a certain time. This means you need to take a market view that also has a time frame associated with it when trading options. You also need to be aware of when your options are expiring in the money since they will generally either be exercised if you are long the option or assigned against you if you’re short the option. This can result in an underlying position you might wish to trade out of, especially if you don’t have the funds required to hold it.
No Dividends on Long Positions
With stock options, when you hold a call option on a stock, you do not receive any dividends paid out to holders of the underlying stock. To receive the dividend, you need to exercise the stock and be holding it on the stock’s date of record for dividend payments, which is generally several weeks before the dividend is paid on the ex-dividend date.
Compared to simply buying or selling an underlying asset, options and the various options strategies you can use when trading them require education to understand and use them effectively.
Knowledge is Power in Options Trading
Options provide traders with a greater choice of ways to express a market view. Since options can add considerable complexity to your trading activities, however, you will want to educate yourself thoroughly about how to best use them so that they boost your bottom line as a trader.
You may want to take an options trading course, read relevant articles, watch related tutorial videos and even hire an options trading mentor. Your online options broker could also provide you with its guides and tips to train yourself with, so check to see what it offers.
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