How to trade options
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Trading options is one of the main ways in which people speculate on future price movements, and can be a useful technique if you’re looking to hedge any long term positions to mitigate risk. This page features the best platforms that allow you to trade options contracts, along with a step-by-step guide for investing and all the key things you need to consider.
Compare the best brokers for options trading
In order to buy and sell options, you will first need to sign up with a stock broker that allows this form of trading. The table below contains the best options trading platforms, with links to take you to each site if you want to get started straight away. Alternatively, keep scrolling down the page if you want to learn more before signing up.
77% of retail CFD accounts lose money.
Trading options – a step-by-step guide
Regardless of which broker you sign up with, the process of trading options will be largely the same (although factors such as fees and levels of customer service will differ). Here are the steps you will need to go through.
- Sign up to a broker. In order to open your broker account, you will usually need to provide your email address and phone number, along with ID documents such as a passport or driving license.
- Choose the asset you want to trade. Sometimes people get ‘options’ confused with ‘stock options’ – which are actually just one type of options contract. While these instruments are commonly used for speculating on stocks, they are also available for other assets, including commodities, forex, and cryptocurrencies.
- Select if you want a put or a call option. Put options give you the right to sell an asset at a certain price, whereas call options give you the right to buy it at that price. Neither of these agreements obligates you to complete the trade.
- Set the strike price. The strike price is the price at which you can either buy (if you have a call option) or sell (if you have a put option) the asset. You want to set this to represent the way you see the value of the asset moving in the future. If you believe the value will fall, then set a strike price below the current market rate, and vice versa.
- Decide on the time frame. Every option has a specified strike price, and a set limit of time during which it can be exercised. European options can only be exercised on the set date, but American options can be used at any time before that date. The longer the period of time an option is valid, the more expensive the premium will be.
- Purchase your option. Once you have followed these steps, you can open your position with the broker. To do this, you will have to pay a price known as the premium. The level of the premium depends on a variety of factors, including the length of the timeframe and difference between the strike price and the current market rate.
- (Optional) execute or sell the contract. You may wish to execute your option contract if the market has moved in the way you anticipated and you are now able to buy or sell the underlying asset at a better rate than the current market value. Or you might wish to sell the contract to another trader before the time period expires. You are under no obligation to do either of these things, but they are the two ways to make money trading options.
What is an options contract?
Options contracts are agreements to make a trade in the future on a specific day for a fixed price. The key difference that sets them apart from futures contracts is that a trader is under no obligation to buy or sell the asset specified in the contract – they can instead choose to let the deal expire. The three central terms related to these contracts are:
- Strike price: The price at which you can buy or sell the asset
- Premium: The price at which the contract can be bought or sold
- Expiration: The date on which the contract ends
Key factors to consider
Before starting to trade using options, there are some things it’s important to think about. Making sure you have spent some time to consider the following will help you mitigate risk and increase your chances of successful trades.
The level of the premium
Options aren’t free – to take out an options contract, you will need to pay a price called a premium. In simple terms, the premium is what the option is worth at that moment in time, with traders able to sell their options to other investors for whatever its current value is at that point in time (just as you can sell an individual stock on one of the best crypto exchange after its value has changed).
An option contract’s premium is determined by a number of factors, the most influential of which are the amount of time left until it expires, the difference between the strike price and the current value of the underlying asset, and the amount of volatility in the market. If an option still has a long time left before expiry, it will generally have a higher premium, with the premium approaching 0 as the contract’s expiration date approaches.
Whether to choose a put or call option
With a put option, you have the right (but not the obligation) to sell an asset at a set price within a certain time frame. These contracts can be used for short selling something you believe will fall in value, or for mitigating risk if you have a lot of long exposure to a specific asset – purchasing a put option, in this case, can limit your losses if the market moves against you.
Call options work the opposite way: they give you the right (but, again, no obligation) to buy an asset at a pre-agreed strike price within a set time frame. Traders often like to use call options as their premiums tend to rise quickly if the underlying asset increases in price, meaning healthy profits can be made by selling them if this happens. Alternatively, just as put options can be used to hedge long positions, call options can be used to hedge short ones.
The risks involved
Because of the many different ways people use options contracts, some of the trades made using them can be risky. These instruments can be used effectively by investors to make trades, but some online forums promote ways of using them which can expose traders to high chances of losing money.
An example of this is that some online traders have taken to investing in ‘out-of-the-money’ options, and investments such as this come with large risks. An out-of-the-money option is one where the strike price is lower (in the case of a call option) or higher (in the case of a put option) than the market value of the underlying asset and therefore the contract is not worth exercising.
Options contracts can be used to make bets such as this (in the case of out-of-the-money options a late swing in the underlying asset’s price can lead to big gains), but it’s always important to assess the risk you’re taking on with any investment.
Why use options contracts?
The two main reasons people use options contracts are to speculate on the future value of assets, or to hedge other investments and mitigate risk. Because options allow you to set a price at which you can buy or sell a particular asset within a set time frame, they can be used by traders both to capitalise from future price movements and to protect against significant market volatility.
Additionally, options contracts provide a degree of leverage to traders. They allow people a guaranteed option to buy a large volume of an asset (e.g. 100 shares in a company) but only require a small premium payment up front. If the market moves in the way a trader predicts, the investor then has the option to buy or sell the asset at a favourable rate, or sell the contract at a profit without ever having to have risked large amounts of capital.
Still undecided?
If you’re still making your mind up about whether you want to trade using options, here is a quick breakdown of the pros and cons to help you decide.
Pros
- Holders of options contracts are under no obligation to exercise them
- Can be used to speculate or hedge existing investments
- You can select the exact parameters of an options contract before buying it
- They are available across a range of markets
Cons
Where can I learn more?
If you want to improve your knowledge before signing up to a broker and trading options, then the best thing to do is learn more about investing. Take the time to understand fundamental and technical analysis so that you can better predict which way markets will move, and take one of our free trading courses to get a clear idea of all the different ways you can trade and invest.
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