Before you start online options trading
Online options trading can be very straightforward and, profitable. It certainly isn’t for everyone; there is a degree of investing knowledge required before advancing to options trading. Before opening your first options trade with real money I would highly advise you to “paper trade” any strategy and/or individual stock option first. By paper trading first you will see how your trade would perform in the real market without risking any of your capital. Do not be too hasty and worry about missing a golden opportunity, all the time the markets present opportunity to those that are patient.
Where I started with online options trading
I was probably nine or ten years old when I first developed an interest in the stock market. I kept all the business sections of the newspaper and would circle certain stocks then follow their performance over time. It was a decade or until I jumped right in and, started trading.
I started trading stock options in 1997 during the tech boom; it was a few years until I began to take part in online options trading. If you recall at the time stock valuations were going through the roof, not only for new dot com start-ups but also seasoned companies. To be honest there wasn’t a lot of skill involved as most seasoned investors will agree. Anyone can make money in a roaring bull market.
The reason I chose to invest in options as opposed to outright in stocks was two-fold. First and foremost was capital I had very little to invest in the stock market. Secondly was leverage, I could gain control over a high flying tech stock with a fraction of the money I would require to outright purchase that stock.
Now a days there is a huge number of brokerage houses that offer online options trading. When selecting a broker you need to consider more than just what commission they charge. Proper analytics are important also. You need to figure out what your potential profit or loss will be on any given trade. The online options trading website also has to be stable and quick. An extra second or two in a fast moving market can cost you money. Always look for an online broker that will let you test drive their trading platform with a trial account using “imaginary” funds (paper trading). Now that we have covered online brokers lets dive into some of the definitions of stock options.
What is a stock option?
There are several pieces of terminology you need to understand before you start online options trading. A stock option is essentially the right but, not the obligation to buy or sell the underlying stock before expiry for a certain price (the strike price). The strike price on an option is also known as the exercise price. It is the price at which you can buy (call) or sell (put) the underlying stock.
A call option gives you the right to purchase the underlying stock at the strike price before the expiry date. Call options are typically purchased when you expect an upside move in a stock. Put options give you the right to sell a stock at the strike price before expiry. There are two main reasons to purchase a put option when online options trading. The first reason is to take advantage of a potential downwards move in the underlying security. The second reason is to hedge against a downside move on stock that you own.
Options on stock expire on the third Friday of the month. Some options called Long-Term Equity Anticipation Securities (LEAPS) usually expire a year or more after they are written. LEAPS can be a very good way of hedging a long position or positioning yourself for a potential move you see in the future.
When you buy an option you pay a premium to the seller. The premium of an option is the price you pay to purchase a stock option.
Determining an options value
Some options have no real intrinsic value only what is called time value. Let’s say a stock is trading at $30 and, you buy a call option with a strike price of $32 that doesn’t expire for 6 months. The option has no intrinsic value only time value because it has 6 months until it expires. Within that time frame there is the possibility that the stock can increase in value to say $34 at which point it would have $2 of intrinsic value.
A final word about online options trading
Derivative trading of any kind involves using a lot of leverage. With this increased leverage comes more risk. Options only have a limited life unlike shares in companies. Trading options should be limited to risk capital only unless you are doing covered call writing or going long puts to hedge a current position. Make sure to paper trade until you get the hang of options trading. Always bear this in mind when doing online options trading.