How to Trade Options for Beginners
Have you traded stocks and now want to learn how to trade options? Then you’ve landed in the right spot. Although this guide is primarily for beginners, more experienced option traders can still learn something new.
The video above covers how to place an option trade using an online trading platform. Also, if you’re interested in option trading strategies and the many investment opportunities out there, you’ll find a whole world of useful ideas here at Investment U.
Option Trading Platforms
To trade options, you’ll need to go through a licensed broker. And thanks to new technologies, anyone can set up a trading account with ease. Although, one important note… once you’ve set up an account, there are some minimum account requirements to access option trading.
In the video above, you’ll see the Investopedia’s Trading Simulator at work. It allows you to learn the ropes of how to trade options without actually putting down real money. Although different brokerages have unique platform designs, their trading steps should be similar.
How to Look Up Options with Ticker Symbols
Brokers use slightly different identifiers to track options. But let’s look a common structure. Here’s an Apple (Nasdaq: AAPL) call option that expires on June 19, 2020, with a strike price of $260…
Up first is the company’s ticker symbol (AAPL) and then the date (200619). The 20 is used for the year 2020 and 06 shows the month of June. Then the 19 represents the day of the month (most option contracts expire on the third Friday of the month).
The C shows that it’s a call option. And if it was a put, you would see a P instead. Then after the letter comes the price. This Apple call example shows a strike price of $260 (00260000).
The Bid, the Ask and the Spread
One of the most important parts of options trading is knowing what an option should sell for and getting it for what it’s worth. This requires knowledge of the bid, the ask and the spread.
- The bid price is what people are willing to buy the option for.
- The ask price is what owners of the option are willing to sell it for.
- The spread is simply the difference between the bid and ask prices.
Most transactions in the options market will take place between the bid and ask.
Also, it’s important to note that options trade in lots of 100 shares. This is known as a contract. When you buy an options contract, be it a call or a put, it gives you the right to buy or sell 100 shares before a specified date in the future.
Types of Option Orders
The next decision is to determine what type of order you would like to put in. If you purchase an option with a market order, it will likely be filled at a price close to the ask price.
If you put in a limit order, you can set the price you would like to purchase at. The limit price sets the maximum you are willing to pay (or minimum to receive if selling an option). For example, if the option is trading at $12.50 but you don’t want to pay more than $11.50, you can set a limit order for $11.50 and the trade will only be executed if the option drops to that price or below.
Duration of the Order
Another important step in trading an option is to choose whether you’re opening a new position or closing an existing one. Then after that, you can set the duration of the trade.
If you select the good until cancel option, this tells the brokerage that the price you set is good until you manually cancel it. In other words, it keeps the order valid until it’s filled and the stock is actually bought, or until you cancel the order.
You can also set cancel dates. So if you select day order, the order will be valid until the end of the trading day. At that point, if the option has not been purchased, the order will be automatically canceled.
Next Step in Learning How to Trade Options
One of the most important steps to learning is applying what you learn. You can practice option trading with virtual platforms like the one shown in the video above. Or you can put some real money on the line with online brokers.
Whatever path you decide, it’s best to look into the specific rules on the platform you use. Also, many paid brokers have customer support that can walk you through trades for free. So have at it and if you have any questions, please leave a comment below.
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