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How to Trade Options
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eToro is a multi-asset investment platform. The value of your investments may go up or down. Your capital is at risk.
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
Copy link to sectionIn 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.
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This information is NOT relevant to EU residents who are to be serviced by EU subsidiaries of the Plus500 Group, such as Plus500CY Ltd, authorized by CySEC (Reg. 250/14). Different regulatory requirements apply in Europe, such as leverage limitations and bonus restrictions.
Trading options – a step-by-step guide
Copy link to sectionStep 1. Sign up with a trusted options broker
Copy link to sectionIn 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.
Options are a specialized product and not all brokers offer them. You can use any of our recommendations above to find an options broker.
Step 2. Understand the basics
Copy link to sectionBefore diving into a trade, it’s crucial to understand a few key terms that will help you navigate options:
- The strike price is the agreed-upon price at which you can buy or sell the asset.
- The premium is the price you pay to obtain the option contract.
- The expiration date marks the last day on which you can exercise the option.
These terms are essential for managing your trades and understanding the risk involved.
Step 3. Choose an options strategy
Copy link to sectionThere are various strategies in options trading, each suited to different market conditions. As a beginner, you might start with the basic strategies of buying calls or puts. If you believe an asset’s price will rise, you would buy a call option. If you expect the price to fall, you would buy a put option.
Step 4. Select the right option contract
Copy link to sectionOnce you’ve decided on a strategy, it’s time to select an option to trade. You’ll need to decide on the asset (stock, index, or commodity) you’re trading, as well as the strike price and expiration date.
When choosing the strike price, consider whether you expect the asset to move significantly in your favor. If you choose a strike price too far from the current price, the chances of making a profit may be lower, but the cost (premium) will also be lower.
On the other hand, choosing a strike price closer to the current price increases your likelihood of profit but will come at a higher premium.
Also, the expiration date is key. The closer it is, the faster the option will lose value due to “time decay.” Longer expirations give the market more time to move in your favor, but they will typically come with a higher premium.
Step 5. Execute your trade
Copy link to sectionOnce 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 the difference between the strike price and the current market rate.
Step 6. Monitor and adjust your position
Copy link to sectionAfter your trade is active, the next step is to keep a close watch on the option’s performance. If the market moves in your favor, you might consider selling the option contract before expiration to lock in a profit.
If the option hits the strike price before expiration, you may choose to exercise it and either buy or sell the asset at the agreed-upon price. If the option fails to perform as expected, it may expire worthless, which means you would only lose the premium you paid for the option.
What is an options contract?
Copy link to sectionOptions 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
Copy link to sectionBefore 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
Copy link to sectionOptions 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
Copy link to sectionWith 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
Copy link to sectionBecause 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?
Copy link to sectionThe 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?
Copy link to sectionIf 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
Copy link to section- 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
