When looking at the benefits of trading options, traders should understand that options are a versatile tool for conquering the markets. In this beginner’s guide to options, we’ll review what it means to trade stock options, the types of options available, and give you an overview of how to get started trading options. By the end of this article, you’ll understand exactly why you would buy an option and how options trading works.
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How Does Options Trading Work?
To understand how options trading works, it’s important to ask what exactly does it mean to trade stock options? To put it simply, an option is just a contract to buy or sell a stock at a certain date at an agreed-upon price, known as the Strike Price. However, there are two types of options that are available, you can buy a call option or put options. The difference between the two: buying calls give the option holder the right to buy, buying puts give the option holder the right to sell a stock.
An option allows you to buy a contract on a stock without having to invest the full cost of the stock. You don’t have to buy or short anything in full. The only out-of-pocket expense if you don’t execute your position is the premium that was paid. Instead, you’re buying a contract that lets you:
- Buy or sell shares at a previously negotiated price
- Sell the contract to another trader
- Let the contract expire and walk away with no consequences (outside of your original investment)
Options are great because you have no obligation to do anything if you’re not happy with the direction your contract is moving. That lack of obligation allows traders to protect portfolios from volatility. For example, If you own shares of NFLX and are concerned about earnings forcing shares down, a put (sell) option allows a trader to lock in a sell position at a certain price.
On the other hand, the share price of AMZN can be too pricey for most traders. However, buying AMZN call (buy) options locks in the stock at a strike price, allowing you to then purchase the stock at that price even if it’s moved up significantly. Traders can then cash in on the difference, or simply walk away. This lets traders take advantage of a symbol’s move without taking major risks.
One important note is that options all expire worthless, generally within a 30-day time frame. If a trader doesn’t take advantage of their call (buy option) or put (sell option) within that period of time, then the contract simply expires with no obligation for either involved party.
What Are the Benefits of Options Trading?
As mentioned above, trading options provide traders with numerous benefits. Perhaps the most important of those benefits is that options enable traders the ability to take advantage of a stock’s move without having to cover the cost of a stock itself. By buying the right to purchase or sell a stock at a specified price, traders are invested in the stock with limited risk.
And because of this lower capital requirement and no obligation to actually purchase the asset, options also allow for better diversification than simply buying stocks outright.
Additionally, options allow for a more conservative approach to trading thanks to the low capital investment. But they’re also more logical and safe than penny stocks and gambles such as IPOs. However, there are numerous options trading strategies that traders can utilize to match their trading style. Options give traders leverage, letting you hedge your account to protect yourself.
Are There Any Risks in Trading Options?
As with any type of trading, options trading has risks. However, these risks are mitigated thanks to the lower cost of options. That being said, any time you invest money into a trade, you’re exposed. If you’re new to trading, make it a point to not invest more than 3% to 5% of your portfolio into any one trade, you need to understand your position size so that way you can trade within your risk tolerance. Additionally, options expire, which can present a risk if you’re not monitoring those exact expiration dates. Practicing with paper trading when starting off to prepare yourself is a good idea for new traders.
How to Get Started Trading Options
Just like trading any security, trading options require a brokerage account. Fortunately, there are several platforms available online, such as Tastytrade. Once your account is set up and approved to trade options, you’ll want to make sure you understand the terms of your account. Brokerage firms set limits based on your experience and funds. Each firm has its own requirements, so make sure you understand your brokerage’s terms. This ensures that traders understand the risks and setups involved in trading options.
You may want to start with paper trading to ensure you’ve got a handle on trading options before using real money. Additionally, invest in your trading education. Keep learning and keep yourself surrounded by a community of like-minded traders to keep you moving forward.
As you get more experience trading options, you’ll find more strategies and benefits present themselves regularly. For new traders, options are one of the safest and greatest investment vehicles available.
Trading options can be complex at a times, but here at Simpler Trading, we have expert traders ready to guide and mentor you through those times of uncertainty. Become a member today and join our traders in the Simpler Central trading room, where you get access to daily premium videos and trade alerts, so that way you never have to trade alone again.
FAQs
Q: Can a beginner trade options?
A: Options can be good for beginners because you have no obligation to do anything if you’re not happy with the direction your contract is moving. Additionally, options allow for a more conservative approach, and smaller capital requirements.
Q: Can I start options trading with $500?
A: Yes, you can start trading options with $500. To trade options you need a brokerage account. Most brokerages don’t have account minimums.
Q: What to consider before buying options?
A: “Before you buy options, make sure you understand how they work, have a brokerage account, make a trading plan. You can also consider paper trading as a practice.”
