How to Get Started Trading Options
Becoming a successful options trader is a lot like being a successful stock trader, requiring a commitment to learning and practice. Time spent on education, strategy development, and understanding the forces that drive the stock options market is crucial. Options traders should have confidence in their ideas, know the purpose of entering a trade, and continually learn from past actions.
When it comes to developing a winning strategy, options, as the name suggests, gives investors greater flexibility than traditional equity investing. There are a wide range of options trading strategies that can be used to generate portfolio income, protect an existing position, or speculate on the direction of an asset.
Let's take a closer look at options, the types of options, and how to place a stock options trade.
What are Options?
An option is a contract between a purchaser and a seller. Just as with stock trading, there is an option buyer and an option seller that settle on a price for a trade to occur. The option buyer agrees to pay a fee, called a premium, to the option seller. The option seller, also called the option writer, transfers a certain right to the option buyer. The option buyer then has the right, but not the obligation, to buy or sell an underlying asset.
The underlying asset may be a stock, a stock index, a commodity, or some other financial security. As the holder of the stock option, the buyer has the opportunity to buy or sell a stock at a specific price referred to as the strike price, which is unique to options trading. It is a fixed price at which the option holder can buy or sell the underlying asset. The option buyer has a deadline called the expiration date, and a decision to buy or sell the underlying asset must be made prior to that specified date.
What to Consider Before Trading Options
If trading stock options is something you're interested in, there are several factors you should consider before diving in.
The options market has many experienced participants that have an advantage over inexperienced traders. Rather than letting this scare you, use it as inspiration to have an awareness of the players, strengthen your skill set, and become a successful options trader.
This requires that you first do an honest evaluation of your investing experience level. Novice investors should start slow by keeping a focus on education and developing a comfort level with the basic options trading strategies. Although options can be a great way to hedge your positions, when not properly understood they can represent a high risk of loss.
It is also important to have a good sense of your personal tolerance for risk. Before engaging in options trading, know both your financial ability and willingness to take on risk. Options can a cost-efficient way to gain exposure to equity without owning stocks themselves. They have tremendous leveraging power and can enhance return potential, but with this advantage comes with significant risks. Equity options can also carry a greater risk especially if trading on margin. Know your personal risk level and know that there are unique risks inherent to options trading.
The popularity of options trading has led to a rise in trading platform choices. Many of today's trading platforms make it easy to trade options. Even the more advanced options strategies can be executed in seconds on the best options platforms. Examine the platform's price transparency, ease-of-use, and fee structure to make sure you are getting the most for your money. Find an options platform that fits your style and is conducive to maximizing your profits.
Webull is designed with the interests and preferences of the self-directed investor in mind. Rather than relying on trading commissions like traditional brokerages, it is focused on creating the most technologically advanced platform with easy-to-use tools. It also offers valuable educational resources and client support. Webull enables options traders to make choices by providing transparent, easy-to-understand real time prices, and charges $0 commissions on stocks, ETFs, cryptos, and equity/ETF options.
How To Choose Options
There are two basic types of options, call options and put options. Unlike when you purchase a stock and receive shares in a public company, when you buy a call or put option, you are entering into a contract. The contract is typically for the right to buy or sell 100 shares of a stock.
When you hear ‘call option', think "right to buy." When you purchase a call option you enter a contract which gives you the right to buy a stock at a specified price up until the contract expires. A call buyer thinks that a stock will rise above its current price. The call option seller takes the opposite view and is obligated to sell the underlying stock.
Over time, if the market price of the stock moves above the strike price, the call buyer will be inclined to exercise the contract. The option is considered "in-the-money" because it has value if exercised. The buyer can then sell the shares at their market price, or hold them in anticipation of further gains, If the buyer chooses to sell right away, the difference between the stock price at the time the contract is exercised and the strike price (minus the premium paid for the option) is the net profit from the trade.
If the stock price does not go above the strike price, the buyer will simply not exercise the option. The option would expire worthless, and the call buyer will lose the value of the premium paid. The option in this scenario would be considered "out-of-the-money."
One of the appeals of buying call options is that losses are limited. For example, imagine stock XYZ currently trades at $50, but could theoretically decline to $0. Purchasing a call option on stock XYZ for $2 limits the potential loss to the $2 per stock premium.
The call option seller's goal is to collect the premium from the call option buyer and not incur any other financial obligation when the option expires worthless. Therefore, some investors sell call options to generate extra income for their portfolio.
When you hear put option, think "right to sell." It is the reverse scenario of a call option. Buying a put option gives the option owner the right to sell a stock at a set price within a certain time period. The put option seller must buy a stock at the option's strike price if the option is exercised at or before expiration.
Similar to selling a call option, an investor may choose to buy a put option if they believe a stock's price will move lower. If the stock does move lower, the put option holder can theoretically sell the stock at the higher strike price, buy it back at the lower market price, and bank the difference as profit. This strategy can help the put buyer to protect a position by offsetting the loss from a stock's decline.
Call option sellers and put option buyers both think that a stock will decline. Conversely, both call option buyers and put option sellers think a stock will rise.
Options Trading Process
In placing an options trade, several decisions must be made. You must decide if a stock will move higher or lower from the purchase date to the expiration date. You must also determine by how much the stock is likely to move up or down, or if it will remain near the current price. Most stock options have several dates and strike price alternatives to choose from.
Before deciding on the details, it is important to understand the basic steps leading up to the execution of an options trade.
Step 1: Obtain Approval
Industry regulations require brokerage firms to have an approval process for options trading. You will be required to obtain permission to trade options. Approval is based on your financial resources, investing experience, and risk tolerance, as well as your understanding of investment objectives and the risks and characteristics of options. The approval process typically takes one to two business days.
Step 2: Develop Your Strategy
Devote a significant amount of time to developing your options trading strategy. What are you trying to accomplish? What strategies can get you there? Are you looking to hedge existing positions or trying to speculate on the future direction of a stock? Take the time to develop a strategy that is consistent with your objectives and risk tolerance.
Step 3: Explore the Options
Once you are ready to place real money trades, continue to be diligent in your research. Spend time identifying contracts that match your targeted position on a stock. Browse through the various expiration dates and strike prices to find an option that fits your timeline and gives you the best chance to maximize your risk-adjusted return. Is the option overpriced, underpriced, or fairly priced? Submit your trade with confidence.
Step 4: Monitor and Learn
Once the trade has been placed, do not forget about it and move on. Active monitoring means looking closely at where the underlying stock is heading and whether your option is in-the-money or out-of-the money. Pay attention to how volatile the stock is and how this impacts the price of the option to gain an understanding of the relationship between volatility and options pricing.
Step 5: Continue to Educate Yourself
Options are a dynamic market where even the most experienced traders win and lose. Whether your trade has been successful or not, it is important to objectively evaluate your results. Make an effort to understand why a trade was profitable or unprofitable. Learn from your success and failures to continually improve your knowledge and skills. At the same time, continue to explore educational resources about options trading to set yourself up for success.
Understand the Risks, Enjoy the Experience
The options market has become increasingly popular in recent years, especially amongst self-directed investors. The possibilities of options are continually evolving. Both individual companies, ETFs, and even entire market indices such as the S&P 500, can be traded through options.
There are several motivations for buying options. Equity options purchases designed to hedge a position can serve as an effective portfolio risk management tool.
Equity options can also be a great way to take a stance on a stock, whether bullish or bearish, without actually buying or selling the stock. Success in these kinds of speculative option trades require you to accurately predict the stock price direction, the magnitude of the move, and the timing. This strategy involves greater risk of loss but can also lead to outsized profits.
An important aspect of trading options successfully is finding a platform that works for you. Ease of use, the availability of educational resources, and affordability are key considerations. The modern options trader must develop a comfort level with the technology to maximize their opportunity for success.
Disclaimer: Options trading entails significant risk and is not appropriate for all investors. Option investors can rapidly lose the value of their investment in a short period of time and incur permanent loss by expiration date. Losses can potentially exceed the initial required deposit. Before trading options please read the Options Disclosure Document "Characteristics and Risks of Standardized Options" which can be obtained at www.webull.com. Index Option contract fee, Regulatory and Exchange Fees may apply.
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