Option trading 101

Puts, calls, strike prices, premiums, derivatives, bear put spreads and bull call spreads — the jargon is just one of the complex aspects of options trading.

Options can provide flexibility for investors at every level and help them manage risk. To see if options trading has a place in your portfolio, here are the basics of what options are, why investors use them and how options trading works.

Just like you can buy a stock because you think the price will go up or short a stock when you think its price is going to drop, an option allows you to bet on which direction you think 101 price of a stock will go. But options are useful for long-term buy-and-hold investors, too.

Investors use options for different reasons, but the two main ones are to limit their exposure to risk on stock positions they already have and to make controlled speculative bets. If the share price does indeed tank, the option limits your losses, and the gains from selling help offset some of the financial hurt.

Two art collectors spot the work of a option new artist in a gallery. The trading one buys an option on a painting. She can either hold onto the asset and see if the value continues to increase, or she can sell it for a profit. An option protects trading from downside risk by locking in the price without the obligation to buy. But at least his loss is limited to just 101 he paid for the contract. Remember, at no point is someone who buys an option obligated to buy the underlying asset.

They can simply walk away from option deal and have enough money left over to shop option something else to put on the living-room wall. Or, leaving the metaphor behind now, to add to their investment portfolio. Twitter: DayanaYochim How to Trade Options Options Trading Terms and Definitions Simple Options Trading Strategies Tips for Choosing an Options Broker Options Trading How to Trade Options Dayana Yochim November 17, InvestingInvesting StrategyInvestments How to Trade Options Dayana Yochim November 17, InvestingInvesting StrategyInvestments When you buy a stock, you decide how many shares you want, and your broker fills the order at the prevailing market price.

A put option gives you the right, but not the obligation, to sell shares at a stated price before the contract expires. This is the strike price — the agreed-upon share price at which you would buy or sell the stock if you trading the option. If the price does indeed rise above the strike price, you make a profit. Option quotes, technically called option chains, contain a range of available strike prices.

Time is the other part of the valuation formula, which leads us to the final choice you need to make before buying an options contract. Every options contract has an expiration date that indicates the last day you can exercise the option.

Your choices are limited to the ones offered when you call up an option chain Expiration dates can range from days to months to years. Daily and weekly options tend to be the riskiest and are reserved for seasoned option traders. For a put option to be in the money, the share price must be lower than trading strike price First, the good news: When you buy a put or call option, you are in no way obligated to follow through on the trade.

Had you 101 speculating and bought shares of XYZ on the open market before the price took a dive, your financial loss would cut a lot deeper. Account minimums and trading costs are important considerations for investors looking for the best brokerage firm to use. But even more important, especially for investors new to option trading, is finding a broker that trading the tools, research, guidance and support you need. In, out of and at the money.

This is the language of options traders — a jargon-riddled dialect of traditional Wall Street-speak. Becoming conversant first requires learning a few key terms. Here are the essentials of options trading for beginning investors Expiration date: The date when the options contract becomes void. Quotes for options contracts are a lot more complex, because multiple versions are available to trade based on type, expiration date, strike price and more.

Bid: The price a buyer is willing to pay for the option. Ask: The price a seller is willing to accept for the option. Historic volatility, as the name implies, is calculated using past price data. It can be measured on an annual basis or during a certain time frame. Higher implied volatility typically means higher option prices because of higher 101 upside for the contract.

At any given moment that an options contract is in play, it is one of three things: 101 the money: This refers to an option that has intrinsic value — when the relationship between stock price in the open market and the strike price favors the options contract owner. Practically speaking, an out-of-the-money option makes buying or selling shares at the strike price less lucrative than buying or selling on the open market.

A call option is out of the money if the stock price is lower than the strike price. At the money: When the stock price is roughly equal to the strike price, an option is considered at the money.

These last two cover types of options traders. Holder: Refers to the investor who owns an options contract. A call holder pays for the option to buy the stock based on the parameters trading the contract.

Writer: Refers to the investor who is selling the options contract. The writer receives the premium from the holder in exchange for the promise to buy or sell the specified shares at the strike price, if the holder exercises the 101. Besides being on opposite sides 101 the transaction, the biggest difference between options holders and options writers is their exposure to risk.

Their contract grants them the freedom to decide when — or if — to exercise the option, or to sell the contract before it expires. If they end up with an out-of-the-money option, they can walk away and let the contract expire. They lose only the amount they paid for the option the premium plus the cost of trade commissions.

For example, when a call holder decides to exercise an option, the writer is obligated to fulfill the order and sell the stock at the strike price. Because of the unlimited downside potential, we recommend that investors just getting started in options stick to the buying holding side before venturing into more sophisticated options trading strategies. Twitter: DayanaYochim Simple Options Trading Strategies Tips for Choosing an Options Broker Options Trading Simple Options Trading Strategies Dayana Yochim November 18, InvestingInvesting StrategyInvestments Simple Options Trading Strategies Dayana Yochim November 18, Investing option, Investing Strategy101 Options investors can do a lot of things with puts and calls: buy them, sell them, buy and sell them at the same time, or get into options spreads of the bull and bear varieties.

Of course, when trading options the goal is to be on the winning side of the deal. But equally important is to limit potential losses. In that spirit, here are three options trading strategies that can help you walk that risk-reward balance beam successfully.

For options traders, a covered call is equivalent to ordering a nightcap to top off a pleasant evening. How it works: A call option is a contract that allows you to buy a stock 101 it reaches a particular price. In other words, your total upside is capped by the premium you received.

In fact, because of the potential liability, most brokerages require option traders to have a margin account if they want to sell calls. Remember, if the trade moves against you, you owe someone shares. A married put works like a prenuptial contract on a stock you already own.

If the share price of a stock you own drops unexpectedly, a married put gives you the right to sell your shares at a guaranteed price in order to cap your loss. How it works: Buying a put is a strategy that options traders use to profit from a stock that is dropping in price. It works like an insurance policy to protect you against big price declines. If XYZ holds steady or rises during the month, you make money on the underlying asset — the stock.

However, your net gains will be diminished option the amount you paid for the premium. But note that the protection is good only for the length of the contract.

If XYZ shares plummet the day after the contract expires, you bear the full brunt of losses. Why use 101 Just like insurance for cars and homes, you buy a married put to protect yourself from potential investment losses. The premium is akin to the cost of the insurance policy. A long straddle is an options trading trading that helps investors deal with FOMO — that is, the fear of missing out on the action. The action, in this instance, is volatility. It gives option unlimited upside potential while limiting potential losses.

How it works: A long straddle involves buying a call option and a put option on the same stock with the same strike price and expiration date. Potential downside: Sometimes big announcements come and go with little fanfare.

Either way, your maximum downside with this trade is the amount of money you paid for the contracts. Why use it: A long trading lets you play both sides of a coin toss, essentially. As long as the share price moves a certain percentage up or down, the trade pays off. Good to know: Option premiums are based on the what the market — aka other investors — predict will happen to a stock.

The higher the premium, the more the market thinks the stock will move, on average, which means you need the stock to move even more in order to break even. Twitter: DayanaYochim Tips for Choosing an Options Broker Options Trading Tips for Choosing an Options Broker Dayana Yochim October 31, BrokersInvestingInvestments Tips for Choosing an Options Broker Dayana Trading October 31, BrokersInvestingInvestments Options trading can be complicated.

Reliable customer service should be a 101 priority, particularly for newer options traders. Consider what kind of contact you prefer. Does the broker have a dedicated trading desk on call? What hours is it staffed? Is technical support available or only weekdays? What about representatives who can answer questions about your account? Even before you apply for an account, reach out and ask some questions to see if the answers and response time are satisfactory.

Options trading platforms come in all shapes and sizes. They can be web- or software-based, desktop or online only, have separate platforms for basic option advanced trading, offer full or partial mobile functionality, or some combination of the above. Check to see if the fancy stuff costs extra. For example, most brokers provide free delayed quotes, lagging 20 minutes behind market data, but charge a fee for a real-time feed.

Similarly, some pro-level tools may be available only to option who meet monthly or quarterly trading activity or account balance minimums. But because commissions provide a convenient side-by-side comparison, they often are the first things people look at when picking an options broker.

Of course, the less you pay in fees the more profit you keep. Discount brokers can charge rock-bottom prices because they provide only bare-bones platforms or tack on extra fees for data and tools. All Trading Reserved Disclaimer: NerdWallet strives to keep its information accurate and up to date.

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