In this article we will show you how to start options trading for the first time and the easy way to make money in options trading. This article is a beginner’s guide to a successful options trading.
Options are not the same thing as stocks because they do not involve ownership of shares in a company.
Let’s begin with an illustration. Assuming that you expect the price of Tesla Stock to rise from $20 to $30 per unit over the next few weeks.
You decide to buy a call option that gives you the right to buy in the market at $25 per unit at any time within the next month.
The price you pay to buy the option is known as the ‘premium’. And the specific time of one month is the expiry date.
If Tesla Stock price rises above $25 being the strike-price before your option expires, you will be able to buy the market at a discount.
But if it hovers below $25, you will not be able to buy; you simply let the option expire and all you would have lost is the premium you paid to open your position.
We do encourage investors to get involved in options trading after weighing the risk options and understanding the way in which to trade options.
We will take you through the whole concept and show you the best strategies to adopt in order to minimize risk associated with options trading.
Let’s get there together!
What is options trading?
An option is also known as stock option or equity option. It is a contract between a buyer and a seller relating to a particular stock or instrument or other securities.
Options trading is therefore the trading of instruments that gives you the right to buy or sell a specific security on a specific date at a specific price.
An option is a contract associated with an underlying asset such as a stock or another security.
Instead of buying and owning the asset directly as a shareholder, you hold a contract that gives you the right, but not the obligation, to buy or sell such asset at a specific price on a specific future date.
If your bet is right and the asset moves up beyond the value specified in your option contract, your option is in-the-money and you can exercise it for a profit. If your bet is wrong and your asset moves downwards your option becomes worthless.
Basic Options Trading Terms You must Know
- Call Option: This involves buying an option that allows you to buy shares at a later time.
- Put Option: This involves buying an option that allows you to sell shares at a later time.
- Exercising Options: This is the decision you make to invest in options trading. The option seller must sell the stock to the option buyer if the buyer exercises the option.
All You need To Know About Options Trading
Options trading originally began in its modern form in the early 1970s, primarily to allow investors to bet on the future prices of securities.
The options buyer may compel the seller of the options to do whatever the contract specifies in terms of price and time set by the options.
Options termination dates can range from a few days to several years. Options that elapses in a year or more from their entry date are typically known as Long-term Equity Anticipation Securities (LEAPS).
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The crucial aspect of an option is that the buyer of the option has the right to exercise the contract, but is under no obligation to do so. Therefore, the option buyer will only exercise the option when he feels compelled by the gains.
Let’s take for instance, that a call option allows the option buyer to pay $50 per share for a given stock. The $50 is known as the strike-price.
If the underlying stock traded in the market for $30 per share, the option buyer would not exercise the option because it would be unreasonable to pay $50 for stocks the buyer could buy for $30 on the open market.
However, if the share price in the market were $75, the buyer would be reasonably induced to go for the option, since $50 will be a deal relative to the prevailing stock price.
Is Options Trading Good for Beginners?
Options trading has potential for profit and with a flexible offer its liquidity is guaranteed.
Analysts have explained that options can also be used as safety net for other investments depending on the strategy employed.
In other words, when you do options trading well, it can be a good means to spread-out your investment portfolios.
You can realize every objective with options just the same way you would realize with stocks or commodities.
You do this with less cost in options trading and attaining a much higher profits from your investment.
Beginners would be comfortable investing in options trading than going straight into investment in underlying instrument.
The reason lies in the cost of investment. It costs less to invest in options with greater prospect for higher returns.
Again, beginners will be comfortable investing in options because of its flexibility and liquidity.
Since the money invested does not get stock over a long period of time it will help the beginner amass wealth by profiting from well calculated options.
How Much Money Do You Need for Options Trading?
A good number of reputable online brokers accept a minimum deposit of less than $1,000 for level 1 options trading which is for covered-Call and cash-secured puts.
Generally, with as low as $1,000 you can commence options trading as a beginner.
The Safest Options Trading Strategies
Options trading can be very complex. It is influenced my multiple market conditions. In fact, market prices change continuously in some markets 24 hours a day.
Regardless of the associated risks and complexity, all options strategies are based on the two basic types of options: the call and the put.
Below are the safest options trading strategies:
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Long Call
In this strategy, the trader buys a call known as going-long a call and expects the stock price to exceed the strike price upon expiration.
The benefit of this trade is unlimited because as the stock price rises, options traders can earn many times their initial investment.
A long call is a good choice when you expect the stock to rise excessively before the option time elapses.
If the stock rises only a little above the strike price, the option may still be in the money, but may not even return the premium paid, leaving the trader with a net loss.
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Covered Call
A covered call involves selling a call option but with a twist. In this regard, the trader sells a call but also buys the stock underlying the option.
Options traders expect the stock price to be below the strike price at expiration.
If the stock finishes above the strike price, the owner must sell the stock to the call buyer at the strike price.
The strategy can transform your already-existing holdings into a source of cash.
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Long Put
Here, the trader buys a put and expects the stock price to be below the strike price by time expiration.
The advantage on this trade can be many multiples of the initial investment, if the stock falls significantly.
A long put is a good strategy when you anticipate the stock to fall significantly before the option expires.
If the stock eventually falls but only slightly below the strike price, it may not return the premium paid, handing you a net loss.
The best options to trade in 2022
When it comes to trading options, stocks are not the only assets available. You can also buy and sell options for many exchange-traded funds (ETFs).
ETFs are diverse investment potentials that combine multiple assets such as stocks, commodities, bonds and a mutual fund that is traded like a single stock.
Therefore, in 2022, the best options to trade are listed below:
1. Nasdaq QQQ Invesco ETF (QQQ):
Nasdaq is the second-biggest stock exchange in the world by market capitalization (right behind the NYSE), it’s no surprise that we see the Nasdaq ETF (QQQ) on this list.
2. Emerging Markets iShares MSCI ETF (EEM):
This is an ETF that combines large and mid-sized companies from “emerging markets,” i.e. those that are not yet considered highly developed.
3. Stocks are generally tradable in options:
For a stock to trade in options the following conditions must be met.
- The underlying assets must be a properly registered National Market system (NMS)
- The company must have at least 7,000,000 publicly held shares.
- The underlying stock must have at least 2,000 shareholders.
- Trading volume must equal or exceed 2,400,000 shares in the past 12 months.
- The price of the security must be sufficiently high for a specific time.
How to Trade Options as A Beginner?
Beginners are always advised to follow the steps below in order to trade options with professional guide:
Step 1: Open an Options Trading Account
Before you can start trading options, you need to have an online brokerage account.
This cannot be compared with opening a brokerage account for stock trading because the latter involves larger amount of capital. Options trading account can be opened with $1000 or less.
Step 2: Determine and Choose the Kind of Options
As a beginner a call option is a contract that gives you the right, but not the obligation, to buy a stock at a predetermined price known as the strike price within a specific time.
A put option gives you the right, but not the obligation, to sell shares at a stated price before the contract elapses.
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Step 3: Predict Your Strike Price for The Options
It is necessary when buying an option to ensures it is valuable only if the market price closes the expiration period of the option in-the-money.
It is always good to buy an option with a strike price that reflects your market price prediction during option’s timeframe.
Step 4: Determine the Option Time Frame
Every options agreement has a termination date. This shows the last day you can exercise the option. Your picks are limited to the ones offered when you call up an option chain.
Options Trading Platforms You Should Consider Using
It is important to note that there is no such thing as the best platform for options trading for every trader.
Their features, costs, and credibility should be assessed with your own parameters in mind before you go ahead to open a brokerage account with any of them.
Analysts considered the following options trading platforms as the best based on a large number of variables including accessibility, efficiency and credibility.
- TD Ameritrade: The best overall options platform and options tools
- E*TRADE: The best web-based options trading platform
- Interactive Brokers: The best for experts who deal in options trading
- Fidelity: The best for beginners/freshers in the options trading business
- TradeStation: The best option platform technology
