With the increase in option contracts traded worldwide from 9.42 to 21.22 billion, the stock market is fast becoming one of the largest markets in the world. As a result, there has been an influx of new traders into the marketplace. Learning how to trade options before moving to the market can save you a lot of money loss.
In this guide, we’ll be walking you through the trading options available and how to navigate your way to becoming a successful trader.
How Does Trading Options Work?
Trading options work in line with the movement of the market. First, you will need to understand when the market will move, in what direction it will move, and how far it will move.
With this, you can predict the future change of price events, which is the key to understanding the value of trade options. When a trading event occurs consistently, chances are that there will be an increase in profit from that event. Simply put, an increase in call value will determine an increase in an underlying stock.
Also, the volatility of the market increases the price of trade options. When the uncertainty about a market is high, it is more likely for the market to result in a higher outcome. So the higher the volatility of an event, the higher the price of the option.
Find a Brokerage and Start an Account
Opening a trade option account usually requires large capital. Hence the need for the right brokerage firm. Your broker needs to know more about you as a potential trading investor before granting you a permission slip.
You need a brokerage to ensure you are financially prepared, and you understand the risks involved in options trading. Some of the requirements you need to open a brokerage account are:
- Trading Experience: Your broker will need to know if you have any form of trading experience or knowledge in investing.
- Investment Objectives: This includes your investment plan in trade options. Your income, capital speculations, and growth.
- Personal Financial Information: You’ll need to provide your total net worth, liquid net worth, and employment information to your broker.
Choose a Stock and Find the Options Quote Table
Understanding how to read a stock is the first step to becoming a successful trader. A trader can purchase one stock option to control 100 shares of stock in an investment. In the same way, he may also buy a put option to sell 100 shares.
When you get an option quote table, select the data, followed by the delayed option quote. Then you enter a stock or ETF symbol and click on the options tab which will grant you access to see the information available in the trade option.
Choose Your Maturity Date and Strike Price
Your maturity date is the date when your contract matures. When selecting a specific option, you must choose your maturity date. The volatility of the market can help you make this decision.
Two factors that should determine the choice of a maturity date are the length and cost of the option contract. With this in mind, you can go on to pick a strike price where your call or put will be exercised.
Choose to “Call” or “Put” the Stock
To call or put the stock, are the two options available in options trading. It simply means buy and sell. A call option gives you the right but not the obligation to buy up to 100 shares of stock, bonds, or other assets at a specific price within a specific time.
On the flip side, there’s the put option. This gives you the right but not the obligation to sell up to 100 shares of stock for a specific amount within a specific time frame. However, a call investor gets to make profits when there is an increase in the underlying assets.
To select a call or a put, you will need the strike price. This is also known as the exercise price. The strike price of an option is the price at which the call or put is exercised as it plays a huge part in how your trade will turn out. Choosing a strike price is one of the most important decisions an investor takes when selecting a trade option.
Enter Quantity, Set Price, and Choose Order Type
Picking an order type allows you as an investor to specify how an offer behaves when it enters the market. With that, you can select an amount of stock to call or put in a session. There are two types of order: the market order and the limit order.
If you enter with a market order, once the stock is at its best price, your order fills immediately. While a limit order will only fill at a particular price. Note that there is a difference between an order price and order restrictions.
Order restrictions allow you to set how the market behaves during the session. Either it stops if not filled by the end of the season or it persists till it’s canceled.
Day or GTC?
The day order is also known as a limit order. It has a stipulation placed on it which expires by the end of the trading session (day) if it’s not completed.
The Good Till Canceled (GTC) order on the other hand is an alternative to a day order. This stays on till it’s filled or canceled by the investor.
How Much Money Do You Need to Trade Options?
When starting to trade options, it’s usually advised you keep the risk minimal and not begin with a large account. Let’s take a look at how much you can trade options with.
Can You Trade Options with $100?
Technically, yes you can. But, it’s a high risk entering a trade with $100. Trading with this amount is putting your money where your mouth is. If you can’t stand the risk of losing your money, then don’t do it.
However, if your strategy is properly calculated and monitored by your broker, then you can enter a successful trade with $100 and make profits. This also applies to trading stocks.
If you’ve got a well-carved-out plan with your broker, then you could enter a trade and make tons of profits. On the contrary, if you don’t, I’ll advise you to hold on till you get a substantial amount to trade with.
What Is the Minimum Amount to Invest in Options?
How much then, would you need to trade with. Truthfully, there are no minimums with trade options. I would normally advise new traders to learn to gradually grow their accounts.
For instance, if you’ve got $100,000 to trade with, you could start with $10,000 and grow from there. Never forget, it’s an uncertain market and so, you wouldn’t want to put all of your money just because you want to enter a trade. Anything could happen.
You can start with as low as $200 or $200,000 whichever rocks your boat. But, whatever experience you get while growing your account stays with you your lifetime. So, the earlier you start to trade the better.
What Are the Advantages and Disadvantages of Trading Options?
Just like every other trade and field of study, trade option also has its advantages and disadvantages. They are:
Advantages of Trading Options
Trading options can potentially be lucrative, if you are a savvy investor. Some of the advantages that come with trading options are as follows.
This is one of the major advantages of trading options compared to stock. But it’s best for disciplined traders who know how to use it. With options, you’re able to control several shares without trying a huge capital to your account.
With options, there are no restrictions as to what amount you could start with. You could do so much with $2,000 in the options market but not so much with the same amount in the stock market. Whatever amount you wish to trade with, is up to you.
There are no restrictions to whatever strategy you may want to trade with. You can also create your unique strategy. Whatever you think will help you take advantage of the market is yours.
Disadvantages of Trading Options
Trading options comes with inherent risks. You should understand them thoroughly prior to engaging in this type of trading. Here are the disadvantages of trading options.
Time decay is one of the worst things that could happen when trading options. The worth of your option reduces by a few percentages every day regardless of movements in the underlying strike price.
Loss of Investment
If a trade goes against you and you hold onto it while the options are out of money at the expiration date, then you may lose every cent you may have invested.
What Is the Safest Options Trading Strategy?
Options are important tools for risk management and trading. It is imperative to understand the stock market and how it works to get the right strategy. However, the safest options strategy is one that allows you to get returns without any huge potential for loss.
There are three top safe options strategies, but the safest of them all is regarded as the covered call. This strategy allows you to purchase actual shares of a company (up to 100 shares) while simultaneously selling a call option.
This strategy is also called the buy-write strategy. The investors’ market opinion should be bullish towards that instrument. Other safe options are buying diagonal spread and buying/selling verticals.
What Happens If No One Buys My Options?
The difference between In The Money (ITM) and Out of The Money (OTM) options in the trade option is the strike price position. This position is relative to the market value of the underlying stock called the moneyness. An In The Money (ITM) option is an option with a strike price that has exceeded the current stock price.
ITMs have intrinsic values. As a result, they are usually priced higher than the OTM option. This intrinsic value makes their price movement by percentage relatively smaller to OTM. ITMs have high price moves, but compared to OTMs, their percentage moves are smaller.
Out of The Money (OTM) option, however, has no intrinsic value. They are less expensive than ITM so this makes them attractive to customers with minimal capital.
ITM and OTM options both have their advantages and disadvantages. However, this doesn’t mean one is better than the other. Frankly, the different strike prices in an option trade allow for any kind of trader and options strategy.
Is Trading Options Better Than Trading Stocks?
There are similarities to trading options and stocks. However, they also have their significant differences which we will look into shortly.
Options are contracts you buy or sell at a given price (known as the strike price), and you hold on to it till its expiration date. Unlike stocks, with you own part of the company, but you’re allowed to buy and sell (up to 100) of a company’s shares. As with most things, options do have pros and cons.
- With options, you’re provided with leverage which allows you to control more stock for the same amount.
- An option contract allows you to take advantage of the price movement with lesser risks.
- Due to the time limit with options, their value decays as it approaches the expiration time.
- To invest in options, more active portfolio management will be required of you.
Stocks, on the other hand, give you the right to own a part of the company. For instance, if a company has a total of 2,000 shares and you own 200 shares, then you automatically own up to 10% of the company. This is the major difference between stock and options. Let’s look at the pros and cons of stock
- In contrast to options, stocks have more liquidity which makes it easier to buy and sell.
- With stock, you have ownership of the company which gives you authority to vet on board matters.
- You do not need to worry about expiration periods.
- There’s no leverage for you unless you purchase on a margin.
- Some stock prices can be expensive, prohibiting you from being able to purchase shares.
Building Credit: The Role of a Financial Advisor
The trade options market is such a large and volatile market and so navigating through the market space is not a walk in the park. Many people tend to wonder why they need financial advisors, they probably aren’t going to trade for you. But, they’ll help you make good financial decisions.
While you might have all the information you need regarding the options market, you may not fully understand them. A skilled financial advisor will help construct a plan to help you achieve your financial goals.
Also, a good financial advisor educates and pre-informs on the hitches that may occur in the future and how to avoid them. Even outside of the market space, the need for financial advisors can not be overemphasized.
And so, with a financial advisor, you have a good track of your finances: investment, savings, and all. They understand the nitty-gritty of trading platforms not neglecting the options market. So liaising with a skilled financial advisor may save you from bad investment plans.