Options Trading 101: What is options trading and how to buy options
Options are one of the popular financial derivatives among investors, although it may seem overwhelming at first. This article introduces how to buy and sell options, options investment strategies, and helps you compare commissions charged by different brokerages. Want to know more about trading options for beginners? Let's read on!
Best brokers for options trading
| Broker | Commissions | Features |
|---|---|---|
| Futu Securities | Premium x 0.2% (as low as HK$3+HK$15 Platform Fee) | Smooth interface |
| WeBull | US$0 | Commission free and $0 platform fee for US stock options trading |
| uSmart | US stock options: Commission US$0.45/contract (Min. US$1.5/transaction) Platform fee US$0.3/contract |
|
| Chief Group | Premium x 0.25% (as low as HK$50) |
|
| Saxo Market | As low as US$2/lot | Competitive commissions |
| TD Ameritrade | US$0.65/contract |
|
What is options trading? Is it risky to invest in options?
An option is a contract which gives the buyer the right rather than the obligation to buy or sell the underlying asset, depending upon if it is a call or a put at a set price on or before an agreed date.
Options give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price. For example, if you expect the price of a currency to rise over the next few weeks, you can buy a call option which gives you the right to buy on or before an agreed date. The price you pay to buy the option is called the ‘premium’. The more the market value increases, the more profit you can make.
However, you don’t need to exercise your right if it stays below your strike price, you can let it expire. In this case, all you have lost is simply the premium you paid.
What is margin?
In order to write or sell options, an investor must deposit cash or securities in their account which is known as margin to enjoy the upside or the downside of buying options.To be more specific, margin is often measured as a percentage of the total value of the open position.
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Other options terminology
Expiration date
The time at which an investor can no longer exercise the right to trade an option
Strike price
The price at which an investor can exercise their rights
The Greeks
The variables used to assess risk in the options market. Each Greek value such as delta, theta, and others is used to assess options risk and manage option portfolios.
Advantages of options
- Limited risk but limited profit potential: An investor can make more profit if the market value increases. However, there is no need to exercise the right if it stays below the strike price, one can just let it expire.
- Flexible investment choices: Option is one of the most flexible investment choices, which can be used to apply a bullish, bearish or neutral strategy to generate income, or for hedging or speculation.
- Low capital requirements: Investors can take a position with very low capital requirements. For example, an investor can do a lot in the options market with US$1,000 although the choices will be very limited in the stock market with just US$1,000.
Risks of options trading
- Subject to expiration and strike price: An option is subject to an expiration and strike price. Option holders can only exercise the right within these limitations.
- Lower liquidity: Many individual stock options have little volume. Since option holders have options trading at different strike prices and expirations, the option that you are trading will be very low unless it is a popular one.
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What are call and put options?
A call option gives the investor the right to buy a stock and a put option gives the option holder the right to sell a stock. Each option contract represents 100 shares of the underlying asset.
Call options
A call option gives the investor the right to purchase an asset at a strike price until expiration. Essentially, those who buy call option contracts bets that the asset's price will rise. The more the price rises, the more valuable the option contract will be.
For example, one XYZ 120 call option gives the owner the right to buy 100 XYZ shares for $120 each (strike price) despite the market price of the shares until expiration. Appreciation above $120 represents the potential payout.
Put options
A put option gives the owner the right to sell an asset at a strike price until expiration. Essentially, those who buy put option contracts bets that the asset's price will fall. The more the asset's price falls, the more valuable the option will be.
For example, you bet that shares of XYZ company will drop below $100 per share and by purchasing a put option, you have the right to sell 100 shares at $100 per share. If the XYZ company's stock drops to $90 then you could exercise the option and make profit.
Options strategies
| Trading options | When to use | How it works | Risk | Profit | Premium |
|---|---|---|---|---|---|
| Buy a call option | Market price rises rapidly | The more the price rises, the more profitable it will be | Lost all premium | Unlimited | N/A |
| Sell a call option | Market price drops slightly | The more the price falls, the more profitable it will be | Unlimited | Premiums | Available |
| Buy a put option | Market price drops rapidly | The more the price falls, the more profitable it will be | Lost all premium | Unlimited | N/A |
| Sell a put option | Market price rises slightly | The more the price rises, the more profitable it will be | Unlimited | Premiums | Available |
Call and put options - buying and selling guide
Buy a call option
An investor can exercise the right to purchase an asset at a strike price until expiration. In short, those who buy a call option predict that the asset's price will go up. The more the price rises, the more profitable the trade will become.
Sell a call option
Call sellers have an obligation to sell the underlying asset at the strike price. The more the asset's price falls, the more profitable it will become.
Buy a put option
A put option gives the owner the right to sell an asset at a strike price until expiration. In summary, those who buy put option contracts predict that the asset's price will fall. The more the asset's price drops, the more profitable it will become.
Sell a put option
Put sellers have an obligation to buy the underlying asset at the strike price. The more the price goes up, the more profitable it will be.
Factors that determine option pricing
Three parameters affect the option's value, including underlying security, time, and volatility.
Current price
If the current market price is high, then the option prices must be high. Conversely, the prices will drop if the market price falls.
Expiration
If time elapses without a significant change in the price of the underlying asset, the value of the option will decline, which is especially true if it approaches the expiration date.
Volatility
Options that have high levels of implied volatility (IV) will result in higher premiums. However, if the demand for an option diminishes, implied volatility will also decrease accordingly, resulting in cheaper option prices.
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Types of Options
Currency
Major currency pairs such as EUR/USD, EUR/GBP, GBP/USD and USD/CHF
Stock
Index
FTSE 100 and Dow Jones (Wall Street)
Commodities
Metals and energy commodities
How to trade options?
Through brokerages
Contract for difference (CFD)
FAQ
What option trading strategies are effective?
- If market price rises rapidly, you can consider buying a call option. Conversely, it’s wise to buy a put option. If the market price rises slightly, you can consider selling a put option. Conversely, it’s wise to sell a call option.
What is the risk of trading options?
- If you buy an option, all that you can end up losing is your premium if the price doesn’t go your way. However, the loss is unlimited if you are a seller.
What does expiration mean?
- It refers to the time at which an option holder can no longer exercise the right to trade an option.