Learning how to trade stock options is actually less intimidating than it seems. In fact, trading stock options is best broken down into four parts:
- Understanding what stock options are
- Deciding if you’re bullish or bearish or neutral
- Selecting an options trading strategy
- Choosing an options trading broker
What are Stock Options?
There are two types of stock options, call options and put options.
A call option gives the buyer the right, but not the obligation, to buy 100 shares of stock at a predetermined price, the strike price, on a predetermined date, the expiration date.
A put option gives the buyer the right, but not the obligation, to sell 100 shares of stock at a predetermined price, the strike price, on a predetermined date, the expiration date.
Options are merely a contract between two parties in the market. However, options are not suitable for all investors. Since one options contract represents 100 shares of stock, options present a high degree of leverage.
Key Options Terms
Knowing a few key options terms will help you understand how to trade. Click on each term to open a detailed description of that term in a new tab.
Strike price = specific price that an options contract is eligible to be exercised
In the money = A call option is considered to be in the money if its strike price is below the current price of the underlying asset. A put option is considered to be in the money if its strike price is above the current price of the underlying asset
Out of the money = A call option is considered out of the money when its strike price is higher than the current price of the underlying security. A put option is considered out of the money when its strike price is lower than the current price of the underlying security
At the money = A call or put option is considered to be at the money when its strike price is equal to the price of the underlying asset
Volatility = the amount of risk or uncertainty a stock or options contract has based on changes in the stock or options contract’s price
Expiration = the predetermined date when the the options contract will expire and no longer be tradable
Are you Bullish or Bearish or Neutral?
The next step to trading stock options is knowing if you’re bullish or bearish or neutral.
If you’re bullish, you expect the stock price to rise.
If you’re bearish, you expect the stock price to fall.
If you’re neutral, you expect the stock to stay in a tight range and move up or down minimally.
It’s as simple as that. If you expect the price of a stock to rise, you would trade a bullish options trading strategy. Conversely, if you expect the price of a stock to fall, you would trade a bearish options trading strategy. Following this logic, if you expect the price of a stock to stay relatively the same, you would trade a neutral options trading strategy.
The number one reason why options trading is popular, besides the increased leverage, is because options allow investors to speculate that stocks might not move at all. Essentially, options make it possible to make money even when the stock market doesn’t move up or down.
Basic Options Strategies
Choosing an Options Trading Broker
Because options are riskier than stocks, due to the increased leverage and possibility of expiring completely worthless, not all brokers let clients trade options.
Most do, however, but conservative brokers will often set “approval levels” that determine which strategies a client can and cannot trade.
More advanced strategies, like short call and short put options, are often not permitted for new options traders.
Options Bro’s Rating
With Ally’s acquisition of TradeKing, excellent trading software is now paired with 24/7 customer service and ultra-low pricing. Among the online options brokers that offer 24/7 customer service, Ally Invest has the lowest commissions and fees.
Ally also has very valuable promotions for active options traders: Up to $3,500 cash bonus + commission free trades for new accounts
See the full Ally Invest review.
Moreover, because options are traded in contracts, brokers charge a per contract fee. This is why it’s paramount to choose an options friendly broker that has very low pricing. Ally Invest is the best broker for options trading, because they have the lowest pricing, 24/7 customer service, and best options trading platform.
Key Points to Remember about Options
If you buy an options contract, regardless if it is a call or put, if it is not in the money at expiration, it will expire worthless.
This is a common reason why traders choose to sell options, because they get to collect the premium.
Although options may not be suitable for all investors, options undoubtedly open up a new world of trading and investing possibilities.