Fidelity
Merrill Edge
E*TRADE
TradeStation
Interactive Brokers
Charles Schwab
tastytrade
eToroHow to Trade Options
Written by Brian Nibley
Fact-checked by Joey Shadeck
Edited by Jeff Anberg
Options are derivatives that allow traders to place bets on the price movement of a particular asset. An option gives its owner the right, but not the obligation, to buy or sell 100 shares of the underlying asset.
Trading options is different from trading stocks in many ways. In this guide, I’ll break down how to trade options by showing how to place a trade, reveal what impacts an option’s price, explain the related vocabulary, go over choosing an appropriate strategy, and examine how to monitor a position.
What is options trading?
An option is a contract that allows its owner to buy or sell 100 shares of a security at a specific price on or before an agreed-upon date. Options contracts can be purchased or sold at any time before expiration.
Options can be traded for a wide range of financial products, including ETFs, indices, and equities. Trading options involves using various strategies to either profit from certain market moves or hedge existing positions in the spot market.
Looking for an options broker?
If you're looking for a broker to dive into options trading, check out our exhaustive guide ranking the best brokers and trading platforms for options trading in 2024.
Featured Offers
How to trade options in 5 steps
1. Open an account and get approved for options trading
After opening an account and funding it, you must be approved for trading options before you can begin trading advanced derivatives like options or futures. This usually involves answering a few questions that demonstrate you understand the risks involved in trading these complex instruments. There are multiple options levels, and the higher the level you’re approved for, the riskier options bets you will be allowed to make. For beginners, option level 1 is all that’s needed - it will allow you to trade options and use the most common strategies.
Important note:
Remember that trading options involves a high level of risk and is more complex than trading stocks. Price movements can be rapid, and losses can be large. Before trading options, you must understand the many different aspects of how these financial products work.
2. Learn the lingo
To learn options trading, it’s necessary to become familiar with a unique set of terminology. Here are a few of the most common terms used for options:
- Strike price: The price at which the option becomes in-the-money (ITM). For calls, an option above the strike is ITM. For puts, an option below the strike is ITM.
- Expiration date or expiry: The date by which the contract must be exercised. Beyond this date, the option becomes invalid.
- Underlier: The underlying asset that the options contract represents.
- Premium: The price that an option buyer pays to an option seller.
- Greeks: These are variables that impact the price of an option. I'll cover the Greeks in-depth later.
- Implied volatility (IV): The likelihood of a significant move in the underlying asset’s price in a given timeframe.
- Intrinsic value: The value of an option as determined by the difference between the price of its underlying asset and the contract's strike price.
- Extrinsic value: The value of an option derived from factors other than intrinsic value, such as time premium and implied volatility.
Becoming familiar with the above terms is a good first step for anyone who wants to learn how to trade options.
3. Determine your objective and conduct research
As with any trade, it’s best to have a plan beforehand. This involves setting an objective, understanding the risk, having an exit strategy, and researching the fundamentals of the underlying asset and its options market.
Some common objectives for options traders include speculation on price movements, hedging an existing position, or generating income. Writing options is the most common strategy for generating income while buying calls and puts is the most common for speculation.
To research the options market, it can be helpful to look at an options chain. An options chain is a list of all the available options for a given asset, as well as their respective variables, such as Delta, implied volatility, and more. Traders can use this information to determine which option best suits their desired risk/reward profile. In general, options that are less likely to expire in the money have lower premiums.
An options chain inside the E*Trade brokerage platform.
For example, a call on SPY with a strike price of 450 and an expiration date of one week when the current price is 449 will have a higher premium than a call with a strike of 460 and the same expiration date. Calls with an expiration date far in the future will also tend to have lower premiums. Finding the desired balance between premiums, strike prices, and expiration dates is one aspect of conducting research on options and will vary depending on your goals.
Once you’ve decided on an objective and know exactly which options bet you’re looking to take, it’s time to place a trade.
Practice makes perfect!
I recommend to try options trading with a paper account first before placing trades with real money. This way, you can get a feel for how to options trade without losing. The reality of options trading can be surprising, so it pays to learn how it works in practice.
4. Place the trade
Placing an options trade is more complicated than placing a stock trade. With stocks, traders only need to select a ticker and initiate a buy order, simply choosing whether to open a market order or a limit order.
With options, traders must choose:
- The underlying asset
- An option strategy (call, put, spread, etc.)
- Strike price
- Expiration date
Here is what an options ticket typically looks like:
There are several choices under the “action” tab. When writing an option, choose “sell open.” When buying an option, select “buy open.” When selling an option, you’ll need to chose “bid x size” to sell into existing bids in the market. For buying options, choose “ask x size” to buy options other traders have written.
To close out a position, select “close open” in the action tab and enter your price and order type. Traders also have the option to close out a position and immediately enter a new one with different conditions. This is called “rolling” an option and might be displayed on a different screen inside a portfolio snapshot.
5. Manage your position
Once the position has been placed, the last step is to manage it. Options are generally not a “set it and forget it” type of investment. They usually require constant monitoring to determine the best exit strategy as timing may be essential.
Have a predetermined exit plan
Having an exit plan can help when managing an options trade. When will you decide to take profits, and when will you cut losses? What market conditions might result in a different outlook on this position? Do you intend to exercise the option or sell it early for a profit? Answering questions like this before placing a trade can remove a lot of uncertainty and help prevent unfavorable decisions.
Pay close attention to timing
It’s also important to monitor things like the remaining time premium and implied volatility when managing your options position. As an option approaches its expiration date, it loses extrinsic value due to time decay. Sudden market moves can lead to dramatic spikes or declines in implied volatility, which can also impact the price of an option.
Deciding when to take profits is more complicated than with a stock, as even when the underlier moves in the desired direction the option could lose value if held for too long, if volatility declines, or for various other reasons. Traders may be inclined to take profits at the first opportunity by selling their options on the open market or exercising early. If you decide to hold until expiration, the option either expires worthless or yields a profit when exercised on the expiration date.
Closing time:
About 65% of option contracts are closed out prior to expiration. This suggests that most traders usually find it most favorable to take action before the option is exercised upon expiration.
Options trading example
It helps to see practical examples to learn how to trade options. Let's say you decide to purchase a call option of a stock.
Imagine you expect Company XYZ's stock, currently priced at $50, to go up to $60 in the next month. You could buy a call option that gives you the right to buy 100 shares of XYZ at a strike price of $55 per share, expiring sometime in the next 30 days (expiration dates typically can be selected in increments of either weeks or months ahead of time). This option might cost you a premium of $200.
If XYZ’s stock price rises to $60, you can use your call option to buy 100 shares at $55 each, then sell them at the market price of $60, making a profit. Your profit would be $500 ([$60 - $55] * 100 shares) minus the $200 premium you paid: $300 total.
However, if the stock doesn't rise above $55, your option expires worthless and you lose the $200 premium. This illustrates both the potential rewards and risks of options trading.
A trader can also choose to sell their option early. This works more or less like a stock trade, where a trader sells the contract to the next highest bidder for a specified price.
Common options trading strategies
There are many different options trading strategies that can be used to profit in any kind of market environment. Here are a few of the most commonly used strategies.
Long calls
Long calls involve buying a call option with a higher strike price than the underlying asset's current price, meaning the option is out-of-the-money (OTM). Traders use this strategy when they expect prices to rise significantly.
Covered calls
Covered calls involve writing a call option on 100 shares of a stock that a trader holds. The strategy generates income and works best when the stock's price trades sideways or downwards.
Long puts
A long put involves buying a put option with a strike price lower than the underlying asset’s current price, in which case the put would be OTM. Traders use this strategy when they expect a sharp drop in prices.
Short puts
A short put involves selling or “writing” a put option without owning the underlying asset. This strategy intends to profit from an asset trading sideways or upwards. If the option remains above the strike price until expiration, the contract will expire worthless, and the seller will pocket the premium.
If the price sits below the strike price upon expiration, the option owner can choose to exercise and sell shares, meaning the option seller will have to buy 100 shares per contract at the strike price. This would result in a loss for the option writer, as they will be forced to buy shares at a higher price than what the stock currently trades for.
Options writing versus options buying
Using short puts and covered calls are option writing strategies, which involve traders selling options. The goal of these strategies is to generate income. In these cases, the trader hopes that the option expires worthless while they hold onto the premium they earned in exchange for writing the option.
By contrast, long puts and long calls are options buying strategies. In these cases, traders hope for the option to move into the money, at which point they can profit by either exercising or selling the option.
Many more advanced options trading strategies exist. There are butterflies, condors, and other strategies with multiple “legs,” or combinations of writing and buying options with different strike prices simultaneously. Note that some of these more complex strategies may require a higher level of approved options trading than just level one.
Pros and cons of trading options
Trading options can be beneficial but also comes with its share of drawbacks.
Pros of trading options
Leverage: By learning how to trade options, traders can place bets using less capital than required for buying shares. The premium for an options contract usually costs much less than the 100 shares the contract represents.
Trading Possibilities: Options allow traders to trade a wide range of assets and indexes. Traders can place long or short bets on volatility, commodities, broad market indexes, and much more.
Profit Potential: Options can be used to make profits regardless of how the market moves. Whether the market moves up, down, or sideways, different options trading strategies can be used to place profitable trades in any market environment. Options can also be used to mitigate losses on existing positions, a strategy known as “hedging.”
Cons of trading options
High risk: While leverage can be beneficial, it also increases risk. Options can be very profitable when the underlying asset makes a quick move in the direction a trader was betting on. Conversely, options can lose value fast, and they can do so for multiple reasons.
High complexity: Unlike equities, which have simple price action that moves up and down, the price of options is influenced by many factors. Some of these factors are known as “the Greeks.” Understanding each of them is necessary for learning how to trade options effectively.
Time decay: Time decay is another factor that influences the price of an option. All options lose value with time, regardless of the price action of their underlying asset. The rate at which an option experiences time decay depends on multiple factors, and the rate varies throughout the option's lifetime.
Be wary!
Option prices can move very quickly, and sometimes an option’s value may not increase proportionately to the underlying asset's desired price movement. In fact, an option can even lose value despite its underlier performing in a way the trader was betting on.
FAQs
How is options trading different from stock trading?
When trading stocks, there is only one goal: purchase shares with the hope of selling them later at a higher price. Stock prices are based purely on current market demand – when buyers outnumber sellers, the stock price goes up (or down if sellers outnumber buyers).
Options, on the other hand, are derivatives and inherently more complex. When the option’s contract’s underlying asset moves up, a call option should increase in value. When the underlying asset moves down, a put option should increase in value.
What are the Greeks in options trading?
Unlike stocks, options have an additional set of variables, including “the Greeks,” influencing their prices. Anyone wanting to learn how to options trade should know about the Greeks. Here is a brief overview of the Greek variables in options trading:
Delta measures how much the price of an option is expected to move for every $1 change in the price of the underlying stock. For example, if an option has a Delta of 0.5, it means that for every $1 the stock price moves, the option price will move by $0.50. Delta values range from 0 to 1 for call options and 0 to -1 for put options. A high Delta indicates the option price closely follows the stock price.
Gamma shows how much the Delta will change for every $1 movement in the stock price. It helps you understand the stability of the Delta. A high Gamma means Delta can change rapidly, making the option’s price more sensitive to the price action of its underlying asset. Gamma is highest when the option is at-the-money and decreases as the option moves in-the-money or out-of-the-money.
Theta measures the rate at which an option’s value decreases as time passes, often referred to as time decay. Options lose value as they approach their expiration date, and Theta quantifies this loss. For example, if an option has a Theta of -0.05, it means the option’s price will decrease by $0.05 each day. Holding an option with high Theta over long periods is very risky for this reason.
Vega indicates how much an option’s price will change with a 1% change in the implied volatility of the underlying stock. Implied volatility measures how much the market thinks an asset will fluctuate in value in the future. A high Vega means the option can change in value quickly when volatility changes.
Rho measures how much an option’s price changes in response to a 1% change in interest rates. While Rho is less critical than the other Greeks for most traders, it becomes more relevant for options with longer time horizons. A high Rho means the option’s price can be more easily influenced by changes in interest rates.
In addition to the Greeks, implied volatility (IV) is another vital aspect of an option’s price. Every option has an assigned IV value at any point in time. A change in IV alone can have a dramatic impact on the price of an option.
Where can you practice options trading?
Here are the top three brokers for paper trading, otherwise known as a demo account, to practice options trading before diving into real contracts:
- Charles Schwab - Schwab's thinkorswim platform offers both an incredibly detailed paper trading account and phenomenal charts and Hacker tools for options trading.
- Interactive Brokers - Trading tools within the Trader Workstation platform are built for professional options traders, encompassing algorithmic trading, Options Strategy Lab, Volatility Lab, Risk Navigator, Market Scanner and other features.
- E*TRADE - For beginner, casual, and active options traders, Power E*TRADE offers the perfect blend of usability, excellent tools and seamless position management — custom grouping, real-time streaming Greeks, risk analysis, and more.
How much does it cost to trade options?
The cost of purchasing options will differ depending on the fee charged by your broker, although most have settled on about $0.65 per contract. Here is the commission charged by each of the top brokers we cover for options trading:
- tastytrade - $0.50 per contract (Stock and ETF options are charged $1 per contract to open, with a maximum of $10 per leg to open, and nothing to close.)
- Charles Schwab - $0.65 per contract
- Interactive Brokers - $0.65 per contract
- E*TRADE - $0.65 per contract (drops to $0.50 if you make 30 or more trades per quarter)
- Merrill Edge - $0.65 per contract
Read next
- Best Stock Trading Apps of 2024
- Best Futures Trading Platforms of 2024
- Best Day Trading Platforms of 2024
- Best Stock Brokers for 2024
- Best Brokers for Penny Stock Trading of 2024
- Best Stock Trading Platforms for Beginners of 2024
- Best Paper Trading Platforms of 2024
- Best Options Trading Platforms & Brokers
More guides
Popular stock broker reviews
About the Editorial Team
Brian Nibley is a copywriter and journalist who has been writing about fintech and finance-related topics since 2017. His work has appeared in publications such as MSN Money, Business Insider, Cointelegraph, BitPay, and Finance Magnates.
Joey Shadeck is the Content Strategist and Research Analyst for StockBrokers.com. He holds dual degrees in Finance and Marketing from Oakland University, and has been an active trader and investor for close to 10 years. An industry veteran, Joey obtains and verifies data, conducts research, and analyzes and validates our content.
Jeff Anberg is a Staff Editor at StockBrokers.com. Along with years of experience in media distribution at a global newsroom, Jeff has a versatile knowledge base encompassing the technology and financial markets. He is a long-time active investor and engages in research on emerging markets like cryptocurrency. Jeff holds a Bachelor’s Degree in English Literature with a minor in Philosophy from San Francisco State University.