Options Trading

Options trading means buying and selling option contracts to profit from, or protect against, price moves in stocks, ETFs and indexes. Options let you express views that shares cannot: limited risk bets, income from time passing, protection against falls, or trades on volatility itself. They also have more moving parts, so a careful, structured start matters more than with any other instrument.

Getting approved#

In the US, brokers assign options approval levels based on your experience, finances and objectives. Lower levels allow buying calls and puts and selling covered calls; higher levels allow spreads; the highest allow selling uncovered options. Approval is a safeguard. Start at the level you understand.

Reading an option chain#

An option chain lists every available call and put for a stock, by expiration date and strike.

Remember the multiplier: an ask of $2.40 means $240 for one contract of 100 shares.

Choosing expiry and strike#

Expiry: short dated options are cheap but decay quickly; longer dated options cost more but give the trade time to work. Many beginners buy options with at least 30 to 60 days left to reduce the impact of time decay. See Theta.

Strike: in the money options cost more but behave more like the stock; out of the money options are cheap but need a bigger move to pay off. See Moneyness: ITM, ATM and OTM.

Beginner friendly strategies#

Spreads cost less than single options and define risk on both sides. See Vertical Spreads.

Placing options orders#

• Always use limit orders. Options spreads can be wide; start at the midpoint between bid and ask and adjust if needed.
• Check liquidity: volume, open interest and a narrow spread at your strike.
• Know exercise and assignment rules, especially near expiration and before dividends. See Exercise and Assignment.

Managing risk#

• Size by the premium at risk: if a trade can lose the whole premium, that premium should fit your risk per trade.
• Watch implied volatility: buying options when volatility is very high, such as just before earnings, often leads to losses even when the direction is right. See Implied Volatility (IV) and Volatility Crush and Expansion.
• Decide in advance when to take profits or cut losses, for example at 50% of the premium.
• Avoid selling uncovered options until you fully understand the tail risk.

Frequently asked questions#

Can you lose more than you invest with options?#

When buying options, your maximum loss is the premium. When selling uncovered options, losses can far exceed the premium received.

How much money do I need to trade options?#

Buying a single option can cost under $100, but small accounts should still size trades so each premium is a small part of the account.

Why did my option lose value when the stock went up?#

Possibly because of time decay, a drop in implied volatility, or because the stock did not rise enough to offset them. The Greeks explain these effects. See The Option Greeks Explained.

Sources#

• U.S. Securities and Exchange Commission, Options
• FINRA, Options