A beginner's guide to options trading
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Thinking about getting into investing? Even if you’re a beginner, having an active interest in smart investing clearly represents the desire to better your financial future. While investments can be a great way to build long-term wealth and make your money work for you, they also require you to know what you’re doing.
Most people have heard of stocks and trading on the stock market, but there are many more ways to invest, including stock options.
Options investing, which is popular with many beginners, allows you to “bet” on how much a company’s stock will be worth in the future, without actually buying any stock. Options can make money if a stock goes up or down—as long as you “bet” correctly on which way the stock would go.
Here are the basics of options investing and what you need to know to get started.
Options vs. stocks
People buy and sell pieces of companies as investments, which are called shares of stock. If you buy a share of stock, you are essentially buying a piece of a company. If the company does well, the stock generally increases in value.
Although the two are related, options are different from stocks. If you buy an option on a stock, it’s called a stock option, and it’s a contract that gives you the opportunity to buy or sell the actual stock in the future for a set price.
A single option is a contract for 100 shares of stock. So if you buy one contract, you are buying the right to purchase or sell 100 shares of stock at a set date in the future for a set price. Likewise, if you buy two options, you are buying the right to purchase or sell 200 shares of stock in the future.
It’s important to note that options can be purchased for other assets besides stock, such as currencies. We’ll focus on stock options here, as they are the most common form of options trading.
Next, we’ll cover the two main options you can buy—a put and a call.
Generally speaking, the two kinds of options you can buy are put options and call options. Here’s an easy way to remember the difference between them—a call option makes money when the stock goes up, whereas a put option makes money when the stock goes down.
So, if you think a company will do well in the future, purchase a call option. Whereas if you think the company will perform poorly, purchase a put option.
Both kinds of options allow investors to bet on the future performance of a company. Once you buy an option, you have a few choices on what to do next.
After purchasing an option
Remember, an option is a contract. That contract gives you the right to buy stock in the future for a set price, called the ”strike price”—but you don’t have to buy the stock.
Buying an option allows you to do a few different things. Here are the common actions an investor can take after buying an option.
Buy the stock associated with the option when the set period of time comes up.
Sell the option to another investor so they can buy the stock.
Let the option expire without buying the stock and walk away.
When it’s time to make a choice, the best path depends on how the stock performed in the time since you bought the option.
If the stock went up and you bought a call option, then you have the option to buy the stock at a lower rate than its current value. In this case, you could either sell the call option to another investor for a profit or buy the stock yourself and sell it at a higher rate.
If the company did poorly and you bought a put option, then you have the option to sell the stock at a higher rate than its current value. In this case, you can either buy the stock at a lower rate and sell it for a profit, or sell the put option so another investor can do so.
However, if the company did not perform how you expected, then the option is probably worthless. In this case, you would lose the money you used to purchase the option, also called the option’s “premium”.
Again, it’s helpful to think of an option as a “bet” between two investors on how a company’s stock price will perform in the future. The premium is the price of that “bet”.
Best options brokers
Most of us can’t trade options on our own. To get started with options trading, you’ll need a broker. Brokers are certified professionals who buy and sell investments on behalf of regular people like you and me.
Nowadays, most broker services can be taken care of online. Online brokers make buying and selling stocks and other assets quick and easy, and two of the most popular and easy to use are E*Trade and TD Ameritrade.
It’s important to do a bit of research here, as some brokers have either low fees or none at all. Some also don’t require an account minimum, so you can start investing with as little money as you like.
Risks of investing in options
Options are popular investments because they allow investors to profit off a company without actually buying stock in it.
Like any other investment, buying and selling options comes with risks and there is generally no such thing as a completely safe bet. When you buy an option, you buy the right to buy or sell an investment in the future. So, in order to make money with options, you’ll need to research and understand the industry in which you make an investment.
It’s important to remember that understanding an industry well enough to make a successful bet on the future of a company takes practice. To make money with options, expect to spend a good amount of time researching companies, industries and market trends.
Investing in options or otherwise can be a great opportunity to increase your earnings and get a significant return on your money. But, it requires due diligence, money you’re comfortable investing, and the knowledge that you’re taking a risk. With a little patience, careful planning, and luck, options can be an excellent tool for investing, especially as a beginner.
Unless otherwise noted above, opinions, advice, services, or other information or content expressed or contributed by customers or non-Varo contributors do not necessarily state or reflect those of Varo Bank, N.A. Member FDIC (“Bank”). Bank is not responsible for the accuracy of any content provided by author(s) or contributor(s) other than Varo.
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