What is Options Trading? A Complete Guide for Beginners

Sophisticated financial instruments don't always have to be out of reach. Options are a powerful tool that can multiply your profits or secure your investments on the stock exchange.

In this article we will explain in simple words, without complicated terms and with examples:

• What does option mean?
• What is options trading?
• How do options work?
• How can you make money with them?
• Do you need them?

What is options trading?

Imagine that you enter into a contract with a friend. You give him a small sum (a premium) for the right to buy from him in the future shares of a certain company at a fixed price (strike price), even if it rises. This is an option: the right, but not the obligation, to buy or sell an asset at a certain price within a certain time.

They are important in financial markets for several reasons.

First, options provide investors with a way to protect their portfolios from potential losses due to changes in asset prices. For example, put options can be used to protect a portfolio against a potential drop in the price of a stock.

Second, options provide the opportunity to capitalize on fluctuations in asset prices without having to purchase the assets themselves. Investors can use options to speculate on the market and make money on both rising and falling prices.

Options also play an important role in risk management. With options, companies can protect themselves from rising prices of products or raw materials, which helps them plan their operations and avoid financial losses.

So, options are a portfolio protection tool, a speculation tool and a risk management tool, which makes them an important component of the financial markets, providing a wide range of investors with the ability to effectively manage their investments. Let's go over everything in detail.

What is an Option Contract?

For a holistic understanding of options, we first need to understand what are options contracts.

An option contract is a financial instrument that gives its buyer the right, but not the obligation, to buy or sell an underlying asset (stock, currency, futures, commodities) at a specific price (strike price) within or before a certain period of time (expiration date).

In other words, an option is a right to choose that you buy for a small fee (premium).

There are two main types of options:

1. Call Option:

Gives the buyer the right to buy the underlying asset at the strike price.

Profit: Gains if the price of the asset rises above the strike price.

Example: You buy a call option on shares of company X at an exercise price of $100 per share. If X's stock price rises to $120 in a month, you can buy it at $100 and then sell it on the exchange for $120, making a profit of $20 per share.

2. Put Option:

Gives the buyer the right to sell the underlying asset at the strike price.

Profit: If the asset price falls below the strike price.

Example: You buy a put option on shares of company Y at an exercise price of $150 per share. If Y's stock price falls to $130 a month later, you can sell it at $150, making a profit of $20.

In addition to the basic types, there are other types of options:

American option: can be exercised on any day before the expiration date.

European option: can only be exercised on the expiration date.

How Does Options Trading Work?

Options trading is a versatile tool that can be used by both speculators and investors to achieve various goals:

• Increasing profits: by speculating on changes in the price of the underlying asset.
• Risk reduction: by hedging their investment portfolios.
• Generating income: by selling options and earning a premium.
• Diversification: of the investment portfolio.

Trading options can be an effective way to increase your profits or reduce your risk in the stock market.

In this guide, we will look at, how to trade options on robinhood, how to buy options on robinhood, how to sell options on robinhood, how to buy puts on robinhood, how to trade options on fidelity.

• Trading options on Robinhood:

Robinhood is a platform aimed at new traders, offering a simple and straightforward interface for options trading.

How to buy an option:

1. Open a Robinhood account and deposit funds.
2. Select the option you want to buy.
3. Click the Buy button and enter the number of options.
4. Check the price (premium) and confirm the transaction.

How to sell an option:

1. Select the option you want to sell (if you have one).
2. Click the Sell button and enter the number of options.
3. Check the price and confirm the trade.

• Options trading on Fidelity:

Fidelity is a platform that offers a wider range of tools and features for options trading, suitable for both experienced and novice traders.

How to buy an option:

1. Open a Fidelity account and deposit funds.
2. Go to the "Trading" section and select "Options".
3. Select the option you want to buy.
4. Click the "Buy" button and enter the number of options.
5. Specify the order type (market, limit, etc.) and confirm the trade.

How to sell an option:

1. Select the option you want to sell (if you have one).
2. Click the Sell button and enter the number of options.
3. Specify the order type (market, limit, etc.) and confirm the trade.

Key Terms and Concepts in Options Trading

To become an options trading pro, it is important to understand the key concepts and grasp, what is a strike price in options trading, what is delta in options trading, what is option price, how are options priced.

The strike price in options trading is the fixed price at which the buyer of an option has the right to buy (for a call option) or sell (for a put option) the underlying asset at a specific point in time. It is predetermined at the time the option is purchased and remains constant until expiration. The strike price is important because it determines the benefit of the transaction and affects the profitability of the option contract.

Example:

• You buy a call option on ABC stock with a strike price of $100.
• If the price of ABC stock rises above $100 by the time the option is exercised, you can buy it at $100 and then sell it on the exchange at the market price for a profit.
• The maximum profit in this case will be limited to the difference between the market price of the stock and the strike price ($100).

In options trading, delta is a measure that reflects the change in the price of an option by $1 when the underlying asset price changes by $1. That is, delta indicates how much the option price will change when the underlying asset price changes. For call options, delta can range from 0 to 1, where 1 indicates a full correlation with the underlying asset price, and for put options, delta can range from -1 to 0, where -1 indicates an inverse correlation with the underlying asset price.

Example:

• The delta of a call option on XYZ stock is 0.7.
• This means that if the price of XYZ stock increases by $1, the option price will increase by about $0.7 dollars.

The option price is formed based on several factors such as the price of the underlying asset, the strike price, time to expiration, market volatility and interest rate. The option price changes depending on these factors, and analyzing them allows us to assess the potential risk and return of the transaction. Delta is one of the key metrics that helps investors evaluate the risk and potential return when trading options.

Studying strike price and delta is an important step to understanding option pricing and assessing its potential.

Options Trading Strategies

Let's go over the basics Options Trading Strategies and give examples for beginners.

1. Covered calls:

Covered calls is a strategy in which an investor owns an underlying asset (e.g., a stock) and simultaneously sells a call option on that asset. This strategy allows the investor to earn income from the sale of the option (premium), protecting himself from losses in case the price of the asset rises.

Example: An investor owns 100 shares of company A and sells a call option on these shares. If the stock price remains stable or decreases, the investor receives a premium for the option sold. If the stock price rises, the investor commits to sell the shares at the strike price, but the investor still earns a premium.

2. Long calls: Long calls are a speculative strategy in which an investor purchases a call option in order to capitalize on a possible increase in the price of the underlying asset.

Example: An investor buys a call option on Company B stock with a strike price of $50 and expects the stock price to rise above that level. If the stock price actually rises above $50, the investor can capitalize on the difference in price by selling the option or buying the stock.

3. Puts and calls (for dummies instruction): Put options are options that give the right to sell the underlying asset at a fixed price. Call options are options that give the right to buy the underlying asset at a fixed price.

Example: An investor purchases a put option on oil with a strike price of $60. If the price of oil falls below $60, the investor can make money on the difference by selling the oil at a higher price according to the option.

For novice investors, it is recommended to start with simple strategies, such as covered calls or long calls, and base their decisions on an analysis of risk and potential returns. It is important to understand the basic principles of options trading and utilize strategies that fit your financial goals and comfortable level of risk. Start with small amounts and gradually expand your knowledge and experience in this area.

Benefits and Risks of Options Trading

In reading this article, you probably have questions what are the benefits of trading stock options, what percentage of option traders make money, can you make a living trading options.

A word of caution

Trading stock options offers investors several advantages:

1. Potentially high returns: Options can have high percentage returns compared to simply buying stock, as the investor is able to use less money to control large stock positions.
2. Flexibility and protection: Options provide investors with the flexibility to manage risk and potential returns. They can be used as a means to protect against losses or as a speculative tool to capitalize on changes in the price of a stock.
3. The ability to capitalize on different market scenarios: With options, investors can make money when stock prices rise or fall, or when the market is sideways.

Regarding the percentage of option traders who make money, statistics show that most traders, especially beginners, despite the high potential for profitability, do not achieve stable profits due to insufficient training, lack of understanding of risks and the need for constant learning.

Сan you make a living trading options? Yes, some professional and experienced traders manage to earn a stable income trading options. However, this requires deep knowledge of the market, technical and fundamental analysis, a well-developed trading strategy, and risk control. It is also important to have psychological resilience, the ability to make quick decisions and the willingness to constantly learn and adapt to changing market conditions.

Choosing a Platform for Options Trading

Choosing the right options trading platform is an important step towards successful investing.

The following factors should be considered when choosing a platform:

• Usability: the interface of the platform should be simple and clear.
• Functionality: the platform should provide all the necessary tools for trading options.
• Trading commissions: trading commissions should be competitive.
• Educational resources: the platform should offer educational materials on how to work with options.
• Reliability: the platform should be reliable and secure.

Let's take a look at the most popular options trading platforms:

Fidelity options trading:

• Advantages:

o Wide range of option instruments: stocks, ETFs, indices, futures. o Powerful analysis tools: charts, indicators, screeners. o Low trading commissions. o A large number of educational resources: articles, webinars, video lessons. o Reliable and secure platform.

• Disadvantages:

o Complex interface for novice traders. o Lack of mobile application for options trading.

2. Ameritrade options trading platform:

• Advantages:

o Simple and clear interface. o Wide range of options instruments. o Powerful analysis tools: Thinkorswim. o Free training materials: Thinkorswim Education. o Active community of traders.

• Disadvantages:

o Higher trading commissions than Fidelity. o Mobile app can be complicated for novice users.

3. Interactive Brokers:

• Advantages:

o Professional platform with a wide range of features and best broker for options o Access to more than 135 markets worldwide. o Low trading commissions. o Powerful analysis tools.

• Disadvantages:

o Complex interface for novice traders. o Not suitable for novice investors.

4. Robinhood options trading

• Advantages:

o Simple and easy to understand interface. o Free trading of stocks and ETFs. o Mobile application.

• Disadvantages:

o Limited selection of option instruments. o No analysis tools. o Not suitable for experienced traders.

Practical Tips for Beginner Traders

Quite rationally, if you are now asking yourself questions how to trade options on robinhood for beginners, how to trade options fidelity?

For beginner traders who want to start trading options, it is important to follow a few basic practical tips:

1. Learn the basics: Before you start trading options, it is important to thoroughly learn the basic concepts and principles of options trading.
2. Opening an account with a broker: In order to trade options, you need to open an account with a reliable broker who provides access to options trading on the exchange of your choice.
3. Training and practice: Before investing real money, it is recommended that you practice on a demo account with a broker.
4. Develop a trading strategy: Determine your financial goals, risk level, time frame and options trading strategy.
5. Risk Management: Protect your investment through proper risk management. Set loss and profit limits for each trade, monitor market conditions, and don't risk more than you can afford to lose.
6. Follow the market: Stay abreast of current events and news that may affect asset prices. Analyze the market to make informed decisions when trading options

By following these tips, beginner traders will be able to successfully start trading options and improve their skills in this area. It is important to remember that options trading involves a high level of risk, so you need to be prepared for possible losses and use sound risk management strategies.

Options trading can be an exciting and profitable endeavor, but it requires a serious approach, knowledge and skills. It is important not only to learn the basics of options trading, but also to constantly improve your knowledge and learn new strategies and techniques.

Do not stop at what you have achieved, but continue to study the world of options trading, apply your knowledge in practice and improve your skills. Only in this way you will be able to achieve success and become a professional in this fascinating area of financial markets. Good luck to you and good deals on the stock exchange!