Upgrade your trading skills with Options

In 2020, the popularity of investing in options hit a record-high, with 7.47 billion contracts traded, marking a significant 52.4% increase from the year prior, according to The Options Clearing Corporation.

Both seasoned and new investors are taking advantage of options trading because it allows them to speculate on the future direction of the overall stock market or individual securities, like stocks or bonds.

Though it may seem overwhelming, options trading is easy to understand if you know a few key points.

What are options

Options are tradable contracts that give the purchaser the right to buy or sell an underlying asset at an agreed-upon price for a specific period of time.  An option has a predetermined life with a fixed expiration date, after which its value is settled among options traders, and the option ceases to exist.

So, if the investor or trader buys or sells an option, it doesn’t mean they actually have to exercise it at the buy/sell point.

Owning an option does not confer any rights or ownership in the underlying security, nor does it entitles the holder to any dividend payments.   Options fall into a category called “derivatives” since their prices depend on the price fluctuations of another security.

Basically, buying options are betting on stocks to go up, or down, or to hedge a trading position in the market.  When used correctly, the asset class offers many advantages that trading stocks and ETFs alone cannot.

If you’re buying a call option, it means you want the stock (or other security) to go up in price to profit off of your contract by exercising your right to buy those stock and then (usually) immediately sell them to cash in on those profits.

A call option gives the investor the right to buy a certain amount of shares (typically 100 per contract) for a specific security or commodity at a specified price over a certain period.

Opposite to call options, a put option gives the investor the right to sell shares and operate in a similar fashion to calls, except you want the security to drop in price in order to make a profit (or sell the put option if you think the price will go up).

Leverage & hedging

Much like CFDs and spread bets, Options are leveraged products that allow you to speculate on the movement of a market, which means that profits and losses can increase significantly.

You can execute a range of options trading strategies, but broadly speaking, trading call options is how you bet on rising prices, while trading put options is a way to wager on falling prices.

For this reason, options were really invented for hedging purposes, meant to reduce risk at a reasonable cost.

How to trade options

If you’re considering trading with options, you’ll have to prove that you have some experience or at least know what you’re doing.  Unlike opening a brokerage account for stock trading, opening an options trading account requires much larger capital amounts.

You’ll need to pay the premium upfront, which then gives you the option to buy the hypothetical stock (call options) or sell the stock (put options) at the designated strike price on the expiration date.

To assess traders’ trading experience, understanding of the risks, and financial preparedness, brokerage firms screen potential options traders. Thus, it’s best to have a pretty solid understanding of trading under your belt before diving into options.