Looking for winning and profitable options trading ideas every day? Click here to apply for a membership with Options Trading Club!
Have you been investing in stocks, commodities, bonds for a long time? You have learned a lot about them and realized that you can predict how they move in the near term. It is time to step up the ladder, ace the game and try your hands on options trading. Options trading is complex and risky. You can make money in stocks without much knowledge, but you will stand to lose in the derivatives market without the right knowledge. For that reason we made this guide for beginner options traders to get started.
Hence, you need to do your homework and understand the lingo of the options market before entering the world of options. You can start here with this guide for beginner options traders.
Options Trading Made Easy – The Ultimate Guide For Beginner Options Traders
What are Options?
First thing first, what are options? As the name goes, they give you an option to buy or sell an underlying asset at a pre-determined price, within a certain time frame.
The pre-determined price is called the “strike price”.
The end of the time frame is called the “expiry date”.
An option is a derivative, which means it derives its value from the underlying asset. This asset can be a stock, bond, ETF, or commodity that trades widely on a recognized exchange. In Canada, options contracts are available on stocks that are in the top 25th percentile of securities listed on Canadian exchanges by volume and market capitalization. Such stocks have an options chain that includes specific options contracts with various strike prices and expiry dates.
An options contract is usually a set of 100 shares. Buying an options contract doesn’t make you the owner of those 100 shares. Hence, you don’t get the privileges of a shareholder, like voting rights and dividend payouts. So why do you trade in options?
Learn the Language of Options Traders
In options, you predict whether the stock price will rise or fall beyond the strike price on or before the expiry of the contract. Accordingly, you buy or sell options.
An options buyer is in a long position, which means he/she has the right to exercise the option once the stock reaches the strike price. The buyer pays a premium to the seller for taking the risk.
An options seller is in a short position, which means he/she has the obligation to buy or sell the shares if the buyer exercises the option. In short, it’s the options seller who takes the risk in return for a premium.
There are two primary options:
A call option gives you the right to buy a stock at the strike price before or on the expiry date. You buy this option when you are bullish.
A put option gives you the right to sell a stock at the strike price before or on the expiry date. You buy this option when you are bearish.
How Do Options Traders Make Money?
Confused! Let’s go through an options trade to understand how options trading can earn you money.
Ron has been monitoring Lightspeed POS (TSX: LSPD) stock for a while. In early May, the stock was in a downtrend and fell below $70. But Ron was bullish on the stock and expected it to rise to $100 in the next six months. Hence, he bought a call option to buy 100 shares at a $75 strike price in mid-May. He paid $5 per share as an option premium ($500).
Ron’s prediction was right, and the stock surged past $85 after the earnings. He has the option to buy 100 Lightspeed shares for $75. This means he earned $500 (after deducting the option premium). As he is still bullish, he can wait for the stock to reach $100 in the next five months and increase his earnings to $2,000 ($100-$80*100).
But if Ron’s bet turns wrong and the stock falls to $65 when the option is close to expiry, he need not exercise the option. He can just buy the shares at a market price of $65. His total loss will be the $500 option premium.
In the above example, Ron had limited his loss to $500. Then why are options risky.
This is because the options seller takes the risk. His gain is limited to the $500 premium if Ron does not exercise the option. But his losses can go beyond the premium if Ron exercises the option when the stock reaches $100. It’s a zero-sum game, where one’s loss is the other’s profit.
Pre-Requisites of Options Trading
Now that you know how options trading works, you might want to give it a try. But there are some pre-requisites before you begin options trading. You will need to open a brokerage account. If you already have one, you need to activate options trading to start buying and trading options.
As options are risky and complex instruments, your broker will ask you a few questions like your trading experience, income and financial goals. Options traders enter the derivatives contracts with clear financial goals. Most people come here to hedge their risk of upside or downside. Some come to speculate and profit from the volatility. It is the speculation part that makes options trading risky.
Best Online Brokers in Canada
This is just a brief. The ocean of options trading is deep. There are many options trading strategies like covered call, long straddle. Many brokers offer educational tools and guides on options trading.
When choosing a broker, look at the various trading tools and research materials it provides. Also, look at the commission it charges. Some of the best online brokers in Canada are:
Questrade – It offers research and trading tools and has a competitive commission.
Qtrade Investor – It has a user-friendly trading platform and robust portfolio analysis tools.
Interactive Brokers – It is an ideal choice for professional traders. It offers one of the best trading tools and has low fees.
Best Online Brokers for Options Trading in the United States
The U.S. has broker platforms with specialized tools for options trading. Some of the best options trading brokers for beginners are:
E*TRADE – It offers good risk analysis tools.
TD Ameritrade – It offers good educational videos, making it apt for beginners.
TradeStation – Its desktop platform has an in-built OptionStation Pro tool streamlined for options trading.
A new beginning
Once you have set up your trading platform and research tools, start planning your options trade. The platform could be intimidating, and you may have doubts while placing the trades. A good way to implement your learning is to get involved in real-time discussions.
Options Trading Club is a discord chatroom where professional investors discuss various options trading ideas and strategies that can prove instrumental in making profits from options.
Keep learning and keep trading.