Beginners Guide to Trading Options

If you watch the adverts before YouTube videos or on free mobile apps, you’ll see many companies promising to make you a quick buck. This may be through trading options, playing mobile games, or gambling. It’s clear that people are searching for ways to make money without having to work another job.

This is understandable, as the past few years have left many people struggling to make ends meet. There are Americans working two or three jobs while still not managing to pay the bills. Unfortunately, the reality is that there are no completely passive forms of income. Those that do offer immediate wealth through gaming come with extremely high risks.

That is not to say that trading options is not a good way to make extra income. On the contrary, it can pay better than most part-time jobs. But if you want to succeed, you need to know the right strategies when trading options. You need to put in the work, or you will be more likely to lose money than to grow your wealth.

To help you get started, here is a brief beginners guide to trading options.

What Is An Option?

The concept of options may seem confusing at first. However, the reality is that it is no more complex than most other financial assets. An option is essentially a contract that gives you the option to buy or sell a particular commodity at a particular value. In other words, options give you the right to trade certain stocks, without the obligation.

Options essentially let you bet on which way you think a stock is going to go. Instead of owning the stock itself, you own the right to buy it or sell it. This allows for more flexibility. You can make quick decisions, multiple times a day, rather than long, calculated investments.

With this in mind, here are the steps you need to take to start trading options.

Open an options trading account

If you’ve never traded options before, you may be wondering why opening an account is considered a step in and of itself. However, opening an options trading account is not that simple.

Whereas other types of accounts require you to prove that you have the funds necessary, to open an options trading account you need to be able to prove that you know what you’re doing. Trading options can get complex, and brokers want to know that you can handle the complexity.

You are also going to need to start with a larger amount of capital than you would need for a regular brokerage account, along with a clear understanding of the risks involved. Options brokers will need you to sign an options trading agreement, with information that demonstrates your preparedness.

In this document, you will need to provide your investment objectives, your past trading experience, your personal financial information, and the types of options you intend to trade. The broker will then assign you a trading level based on your level of risk, which will determine what trades you are able to make.

It is important that you do your research on the brokerage as well. Do not choose a brokerage that promises immediate wealth, especially if their screening standards seem low.

Pick options to buy or sell

Once you have an account open, you can start trading options. The first step to doing so is to choose which stocks you want to trade. Then you can decide whether you want to buy or sell.

Buy a call option and sell a put option if you predict that the stock will increase in value. If you think it will decrease, however, you should buy a put option and sell a call option. You may predict that the stock price will stay stable, in which case you should sell a call or a put option.

Choose a strike price

The option strike price is the value to which you expect the stock to rise or drop by the time the option expires. In other words, if you think that a stock trading for $100 will dip to $80 during the next week, you will buy a put option with a price above $80 that expires seven days from now.

The strike price you choose will be based on the quotes provided by your brokerage. You cannot simply pull a figure out of thin air.

Choose a timeframe

As mentioned, the strike price you choose is the price you expect the stock to reach by a certain date. This may be days, weeks, months, or years from now. As with the strike price, you will have to choose from the expiration dates provided by your brokerage. The dates they give you will depend on your risk level. Since day trading is the riskiest form of options trading, you will need a low risk level in order to choose a timeframe of days or even weeks.

This is the basic process you go through to trade options. However, you should study some of the strategies for trading options before jumping in head first. According to Roger Wohlner “There are a wide range of options trading strategies to accomplish a wide range of objectives that an investor might have”. Options can present an opportunity to enhance the value of your portfolio and hedge against some of the downside risk inherent in your portfolio”

Trading options can be risky and it is not a get-rich-quick scheme. If that is what you are looking for, then this is not for you. More importantly, if that is what a brokerage promises you, they should not be trusted.

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