What is Stock Options Trading? Your Guide to Getting Started
As investors become more involved in the stock market, they often come across a different type of trading known as stock options trading. Investors classify stock options separately from stocks, bonds, ETFs, and other types of common assets. Instead, they are considered a form of security known as a derivative.
It is important to note that stock options carry more risk than stocks due to the limited time horizon for investors. Stock options call for investors to essentially speculate on how a particular stock market price will rise or fall.
The two biggest differences between common stocks and options are time horizon and leverage.
With common stock, you own a small share of the company's profit or loss, and you can hold it for as long as you want. However, with options, one option represents control of 100 shares of the underlying stock until the expiration. Due to this increased leverage and shorten time horizon, options trading is considered highly risky.
How long can you hold on to stocks?
Investors can hold on to stocks for years and let them accumulate wealth over that time frame, even if the stock has some up-and-down moments. However, options get traded much faster and have an expiration date, after which people can no longer use the options.
Because stock options are versatile, and can be bought and sold, experienced investors can use stock options to help protect their accounts from excessive financial losses.
How does stock options trading work?
Stock option trading works by giving an investor the right, but not the obligation, or buy or sell at a particular price. As you get involved with stock options, you will encounter two main types of options contracts.
● Call options. A call option gives you the right, but not the obligation to buy shares at a particular strike price no later than the expiration date.
● Put options. A put option gives you the right, but not the obligation to sell stocks at a particular price within a specified window of time or expiration date.
It can be helpful to think about these options as speculation. The investor who thinks that the specified price will rise, and thus buys a call option, places a bet against other investors that the price will rise to this theoretical point and generate greater profits. The option seller and the option buyer must each decide based on their interpretation of the option position.
To make these wagers, you will have to pay for the stock options contracts. This charge is known as the option premium. As investors make their bets, they want to ensure that the potential profit they can gain from their option will cover the premium cost.
How to get started in stock options trading?
Investors interested in becoming involved with options trading should make sure they have a solid understanding of stocks and the workings of the stock market. Since there is greater risk involved and more complex factors that decide if you want to buy or sell options, novices to investing may struggle. Moomoo offers options courses to help you understand buying and selling options. Take advantage of the free options trading courses to start selling If you feel ready to get involved in options trading, here is what you need to know.
and buying with confidence.
Open an options trading account
To open your options trading account, be prepared that the process will involve more steps and greater scrutiny than a typical stock trading brokerage account. Instead of just filling out your information and linking your bank account, you will likely need to demonstrate your access to a certain amount of capital or assets.
You also need to demonstrate your understanding of the stock market and how trading options work. The broker will want to be sure that you understand the risks involved with options and will likely want to see that you approach this type of trading with particular goals and objectives in mind.
When you get approved to trade in stock options, many brokers will assign you a rating level that indicates the level of risk you can take and the types of options trades you can make.
Research the different trading platforms and brokerage options available for an options trading account. You want to find one that offers you a wealth of information.
The moomoo app can help you stay current with the ever-changing stock market news and trends to help you consider your buying options. Moomoo app is a trading platform that provides you with in-depth stock analysis tools to help you make the best investing decisions, but also is zero commission trading in the U.S., stock market, and EFTs for U.S residents.
Research the options you want to invest in
The next step will involve ample research. Remember that to make a successful options trade, you need to know which direction the stock will likely go, by how much, and within what time frame. Carefully watching the movement of the stocks and how they respond to different market conditions in the short term can help you better predict the optimal options for your account.
As you start to feel more confident in your ability to predict the movement of the stocks, consider how you want to use the stock options-- such as to protect your other investments from a falling market-- and how you would like to make your wager.
If you think the market price will go up, you can buy a call option (the right to buy shares at a particular price) or sell a put option (the obligation to sell shares).
If you think the price will go down, you will want to either sell a call option or buy a put option. The choice you select should reflect your overall investment goals and what you want to accomplish with your options trading.
Understand how an option premium is calculated
To buy stock options, you will need to pay for the contracts. Option premiums are fees charged to option contracts buyers. You will need to understand how the market calculates premiums so that you can take this charge into account when considering potential returns from options trading. Make sure that the options you buy have enough profit potential to cover the premium you will need to pay for the options contract.
The premium charge depends upon three data points.
● The intrinsic value - is the difference between the strike price-- the value at which you can buy or sell the shares, and the current market price.
● The time value - is the amount of time until the contract expires. A contract that will not expire for weeks has a significantly higher time value than one that will expire in a few days. Once the contract expires, it is worth nothing.
● The implied volatility - tracks whether or not this particular stock will likely take large swings-- high volatility, or not-- low volatility. A stock with greater volatility will have a higher premium than one without that volatility.
Predicting the specific price and time frames to buy
Once you have armed yourself with research regarding the stocks that interest you and understand the premium calculations that will impact, start making predictions about the strike price and the time frames you want to see on your contracts. Some options investors feel more comfortable testing their predictions and estimates before actually making options purchases.
Keep in mind, as you start to determine the prices and time frames for different options, option quotes will determine the stock price options. You cannot just name any price you think the stock will hit. Instead, an option chain is generated by a matrix that will provide a range of possible price options traders can use.
Similarly, the expiration dates available on the options contracts also get calculated by an options matrix chain. The further away the expiration date is, the more time the option can become profitable, which impacts how expensive the option will be to purchase. Your option strategies will need to reflect these predetermined prices and expiration dates.
Get started with options trading
Trading stock options can offer you many opportunities to build your wealth and create a diverse and profitable investment portfolio. You will want to properly educate yourself on options trading strategy and the stocks that interest you before heading in. If you are ready to open an account, see how the moomoo stock trading platform can help you get started trading.