A Beginner's Guide to Options Trading
November 11, 2020
Links to external websites are not managed by Varo Bank, N.A. Member FDIC
Thinking about getting into investing? You came to the right place.
Investments can help you build wealth—if you 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.
Options investing is popular with many beginners. It’s easy to learn the basics.
Options are a type of investment that allow 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 down or up—as long as you bet correctly on which way the stock would go.
We’ll dive into the basics you’ll need to know before getting started with options investing.
Options vs stocks
People buy and sell pieces of companies as investments. These pieces are called shares of stock. If you buy a share of stock, you are buying a piece of a company. If the company does well, the stock increases in value.
Options are different than stocks, but the two are related. If you buy an option on a stock, it’s called a stock option.
A stock option is a contract. That contract gives you the option 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, since 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. A put option makes money when the stock goes down.
So if you think a company will do well in the future, buy a call option. If you think the company will perform poorly, buy a put option.
Both kinds of options allow investors to bet on the future performance of a company.
Once you buy an option, also called a contract, 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 that’s 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 comes 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 the 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 the 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 expect, then the option is probably worthless. In this case, you would lose the money you used to purchase the option.
The money used to purchase an option is called the option’s “premium”. So you would lose the premium you paid for the option.
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 personally. 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. Now most broker services can be taken care of online.
Online brokers make buying and selling stocks and other assets quick and easy. If you want to buy options, we recommend E*Trade, Robinhood or TD Ameritrade.
All three of these online brokers are easy to use. And most importantly, all three have either low fees or none at all, and none of them have 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 the company.
Like any other investment, buying and selling options comes with risks. 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 understand the industry where you make an investment.
Understanding an industry well enough to make a successful bet on the future of a company takes time. To make money with options, expect to spend a good amount of time researching companies and industries.
If you are patient and careful, options can be an excellent tool for investing. Just make sure to do your homework first!
Opinions, advice, services, or other information or content expressed or contributed here by customers, users, or others, are those of the respective author(s) or contributor(s) and 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).