Trading Options For A Beginner
Restored from the Empower Network archive (2011–2017), lightly edited to meet our current advertising standards. Views are the original author’s.
Understanding the Options Market for the Persistent Beginner
First, let’s look at the definition of an Option.
Option – A contract that grants the holder the right, but not the obligation, to buy or sell a particular security at a predetermined price for a set period of time.
I’m going to explain exactly what this means and I’m going to give examples. You are going to learn some terminology along with the examples I give, and so, please follow along with the chart given.
There are 2 types of options. Call options, and Put options. You can purchase or sell call options and you can purchase or sell put options. The predetermined price of the contract is called the “Strike Price”. There is also an expiration date for the contract which is the 3rd Friday of a given month.
1 contract involves 100 shares. So if you have 10 contracts, then that involves 1000 shares.
This allows for leverage, but remember, the options market is very lucrative. I’m going to show some examples here.
The chart above shows the options for ticker symbol SLV, Silver. Down the middle, you see numbers ranging from 13.00 to 30. These are the “strike prices”. The left side of the chart is the “Calls” side. The right side is the “Put” side. This is a September 2013 contract and so the expiration date is on the third Friday of September 2013. There are 19 days left til expiration.
The buying price is known as the “Ask” and the selling price is known as the “bid”.
Let’s say you buy a call option at the strike price 23.00.
You would only do this if you believe the contract will raise in value for you to sell before the expiration date. Typically, you would want to purchase call options further into the future rather than this close to expiration.
When you buy a call option, you are basically betting that the value of SLV is going to go up. When you buy a put option, then the reverse is true. You are betting SLV is going to go down in value.
Those that are highlighted in yellow on the chart are considered “in the money”, and those with just a white background are considered “out of the money”. As you can see, the further “in the money” the options are, the higher their value. Compare the strike price to the actual price of SLV and notice how the Call side is “in the money” at 22.00, but “out of the money” at 23.00.
Now do the same for the put side and notice how the strike price is “in the money at 23.00, but “out of the money” at 22.00. This is because SLV is at 22.6. Options that are “in the money” tend to be more volatile than options “out of the money” with some exceptions.
There are many factors that determine the price of any given option, one of which, is the expiration date. Options which are bought must be sold before expiration, or the option will expire worthless. Options can be very volatile, and therefore, extremely lucrative, but it also provides extraordinary leverage.
For a relatively small amount of money, you can control thousands of shares and you can make a lot of money fast as well as lose a lot of money fast.
With stocks, you have to buy before you can sell. With options, you don’t. You can sell before you buy as well.
For example, let’s go back to the call option at strike price 23.00. The “bid” price is at .64. Let’s say you believe the price of SLV will drop or remain stagnant til expiration of contract, so you decide to “sell” a contract for .64 at the strike price of 23.00.
In this case, since you are selling a call option rather than buying, then you are betting the price of SLV will drop.
Vice versa, if you were selling a put option, you would be betting the price of SLV will rise.
So, buying a call option and selling a put option means you’re betting the security will rise.
Selling a call option and buying a put option means you’re betting the security will drop.
Whatever it is that you do, whether you buy or sell call or put options, you start out by opening a contract. The contract must be “filled”, for the trade to take place. That is, whenever you buy/ask, somebody on the other end must sell that to you and fill the order.
Whenever you open a contract by selling an option, the order is only filled if somebody on the other end buys the option for your specified price. So, just because you open a contract, does not mean that you’re in the market. The order must be filled first, and then you’re in the market.
Be sure to understand this aspect of options trading. This is the basics of options trading. Buying and/or selling call and put options is how you play the game. So if you want to play, you must understand everything stated above. You’re welcome to leave questions in the comments section if you need answers.
This is just the beginning of understanding how to play in the options market. Being able to purchase multiple contracts in the same security as well as other securities, and having the flexibility to play betting both ways, whether the value goes up or down, allows for people to apply strategy to maximize profits and limit losses.
For example, you could buy one call option at a lower strike price, buy one call option at a higher strike price, and you could sell 2 call options at a middle strike price, involving only 3 strike prices on the same security. This strategy is known as the “Butterfly Spread”, which allows for a limited reward and limited risk play.
There are many strategies to use which expert traders have been using for years to make a profit. Some people have it down to a science and have figured out how to come out profitable as long as the value of the security moves either way.
Other methods involve mixing the use of call and put options in different time intervals. You could buy a put option in a September 2013 contract, but buy a call option in a January 2014 contract. In this case, you’re either betting the price of SLV will drop in September, but will rise overall in the coming months, or you’re using one of the options as a way to limit the risk you’ve taken with the other.
In no way am I making any recommendations here. I am not recommending anybody to take any of the actions I have used as examples on this blog. I simply wanted to explain the basics for beginners who are trying to understand how to play the market.
I tried to explain it in an easy way so that it is easily understood, but I found that a little more difficult to do than I anticipated. The terminology and language must be learned to fully grasp how to play.
I touched only on the basics of playing the options market, and so there is more to learn if you’re new. You have to know what it means to go “long” and to “short”, margin calls, and a whole array of other things which can only be learned over time, practice, and persistence.
Trading options is one of the methods I use to make money online. We’re living in a new age where technology is integrated into our everyday lives and is invading the business aspect of our lives more and more. As technology is taking over many jobs like manufacturing, it is also opening up new avenues to make money online.
Back in the day, you needed a broker to do trading. Now, you can do it yourself online. You can trade stocks, futures, options, exchange traded funds, etc., completely online on your own. You can sell products online. You can start a business online. This is really good considering that you no longer have to be strapped down at a location because of a job in order to make money. Now, as long as you have internet connection, you can make money anywhere around the world at any time with multiple streams of incomes.
Please leave comments below, or any questions you may have about the Option Market. I hope I have been able to help educate you about the Options Market. The online broker I personally use is OptionsXpress. They offer a Virtual Trading program that allows you to make trades with fake money. This way, you can practice and learn without having to lose a single dime, until you’re comfortable enough to play with real money.