A long time ago, options trading was only for the pros. However, it’s becoming easier every day for beginners to start using it. Just a few years ago, options trading had an average of 20 million contracts per day, and it’s only been going up since then!
Options trading is good for beginners. It involves less commitment and can be perfect for hedging stock investments. Start with simpler strategies, such as the long call and short call, and move on to more complex scenarios as you gain experience. Options trading can be profitable if you learn.
Before you start options trading, you will want to know the basic terminology. Plus, you should be familiar with some beginner strategies before making your first trade. Read on to learn more.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
Is Options Trading Right for You?
Before starting, you should consider whether this form of investing is right for you. Options trading isn’t for everyone, but most people who try it love it. It can also significantly strengthen your portfolio, so those who use stocks can benefit.
Options trading is fast-paced and hands-on, and you need to react quickly before your contracts expire. If you want an active role in your trading, options can be a good choice.
What Is an Option?
An option is essentially a contract to buy or sell a company’s shares. Each contract comes with a set price and an expiration date. The owner has the right, but not the obligation, to buy or sell the corresponding shares at the determined price and date or let the contract expire.
An example can make the idea easier to grasp:
Say a trader believes that Acme’s shares will rise significantly in the next three months. Right now, they’re trading at $150 per share, so the trader pays some money (called the premium) to have the right to buy the stocks at today’s prices but in three months. Note that the premium is distinct from the share price. The trader is only paying this premium to obtain the right to buy the shares at a later date—you can think of it as paying to call dibs on a stock!
If prices do rise, the trader can buy the shares at the lower price stated in the contract and pocket the difference. On the other hand, if the price stays the same (or drops), they simply let the contract expire and write off the premium as a loss.
With options, you are also not required to make a sale. You can hold onto the contract and allow it to expire. If you decide to do so, you won’t have to pay more money, but you’ll lose the opportunity to make a sale after the expiration date.
A single option is usually worth 100 shares. You can buy more if you plan on trading at higher stakes.
What Is Options Trading?
Options trading involves buying and selling options contracts, which is similar to handling stocks and bonds. The most significant difference between the two is that you don’t gain ownership of a company by having options.
Options trades are also much more flexible. They can include several different assets:
- ETFs
- Stocks and bonds
- Commodities
- Indexes
The prices of these assets fluctuate, making the goal to sell when you can make a profit. There is some risk to options trading, but you can easily navigate it with a good strategy.
Options Trading Lingo
These are a few terms you need to be familiar with when trading options:
- Expiration Date: The exact time when your option’s contract ends, after which you can’t buy or sell the option.
- Strike Price: The price of the asset in the option contract.
- Premium: The amount you pay to obtain the option contract.
There are two types of trading options. They determine whether you should buy or sell your contracts:
- Call Option: Call options allow you to buy shares at the strike price. They may also obligate the owner to sell them, depending on their option contract agreement.
- Put Option: Put options mean you currently have the right to sell at the strike price. If you use it, you are required to sell the shares. You collect the strike price for each option.
Knowing all of the financial trading terms will help you recognize what’s happening. Plus, being informed is essential to making good trades. You should read up on your trading jargon when you can. Stock Trading Terms – Financial Education Is Your Best Investment by Thomas Herold is an excellent digital book to check out.
Options Trading Beginner Strategies
Options trading is fast-paced, and you have the potential to make a large profit quickly using the right strategy. However, you should spend time planning before you act.
No matter how complex, all trade plans need to focus on calls and puts. So, let’s break down some easy beginner strategies for you to learn from below.
The Long Call
The long call involves buying a call when you expect the stock price to rise before the option expires. You should only do this with stocks you think will shoot up. If they do, you earn back multiple times your investment!
This strategy is the most basic of all the plans out there, so it is excellent for beginners. All you need to do is buy the option and sell it before it expires at a higher price. Plus, you get several benefits.
You spend less money to trade more shares instead of putting the funds into buying only one stock. Additionally, the process is simple, allowing you to learn how stocks work without too much pressure. You can buy one option and use it as a way to gain experience.
The Short Call
In a short call, you agree to sell a call option above the current market value because you think a stock is overvalued, and its price will eventually fall. However, since it is a call option, you will be required to sell the shares at the strike price if the buyer executes their option. Normally, this isn’t a problem. But if your predictions go wrong and prices increase, you will have to sell the stock below the new market price and take a loss.
This strategy works best in a bearish market—a downtrend. And the stock’s price needs to stay under the strike price for you to make a profit. Time decay helps you with short calls.
The Covered Call
A covered call allows you to earn stock after holding options for an extended period. To start, purchase shares of a stock, then sell one call per 100 shares. By doing so, you are protecting your investment and making a profit when the stock prices change slightly. It also allows you to reduce potential losses.
After completing a covered call, you now own 100 shares for every call option sold. That means this trade is much less risky than most others, as the shares can generate an income for you.
This short video explains the strategy in detail:
The Long Put
With a long put, you expect the stock price to go below the strike price by the time it expires. It’s good to use when you think the stock will drop dramatically. If it falls only a bit, you may incur a loss.
It’s much safer than shorting your stock, but the price can never go below zero, which caps the amount of money you can make.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
- Best Trading Courses You Can Take For Free (or at extremely low cost): I reviewed 30+ trading courses to recommend you the best resource, and found Trading Strategies in Emerging Markets Specialization on Coursera to beat every other course on the market. Plus, if you complete this course within 7 days, it will cost you nothing and will be absolutely free! Click Here To Sign Up Today! (If you don’t find this course valuable, you can cancel anytime within the 7 days trial period and pay nothing.)
- Best Passive Investment Platform For Exponential (Potentially) Returns: By enabling passive investments into a Bitcoin ETF, Acorns gives you the best opportunity to make exponential returns on your passive investments. Plus, Acorns is currently offering a $15 bonus for simply singing up to their platform – so that is one opportunity you don’t want to miss! (assuming you are interested in this platform). Click Here To Get $15 Bonus By Signing Up For Acorns Today! (It will take you less than 5 mins to sign up, and it is totally worth it.)
Conclusion
As a beginner, as long as you take the time to learn about options trading, you have the potential to succeed. This form of trading is challenging but great for anyone who wants to have hands-on financial experience.
I have plenty more articles on my site about options for you to read. I recommend that all beginners take a look before they make their first trade! Being prepared will help you learn options trading faster. Plus, you can make more informed decisions.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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