How Much Money Can You Make Trading Options

Trading stock options can be complex — even more and then than stock trading. When you purchase a stock, you just make up one's mind how many shares you want, and your broker fills the social club at the prevailing market price or a limit price you fix. Options trading requires an agreement of advanced strategies, and the process for opening an options trading account includes a few more steps than opening a typical investment account.

» Is options trading meliorate than stocks? Learn about the differences between stocks and options

And trading options isn't for the faint of heart, says Wendy Moyers, a certified financial planner at Chevy Chase Trust in Bethesda, Maryland.

"The pros are you could make a fiddling bit actress money on investing in the short term," she says. "The con is you could lose everything, depending on how you construction your options trading. Information technology'south definitely more complicated, and you have to be on top of it all throughout the trading day."

How to trade options in iv steps

1. Open an options trading account

Before you tin kickoff trading options, you'll have to prove you know what you lot're doing. Compared with opening a brokerage business relationship for stock trading, opening an options trading account requires larger amounts of capital. And, given the complexity of predicting multiple moving parts, brokers need to know a flake more than well-nigh a potential investor before giving them a permission slip to start trading options. Moyers says people who know the market well, and have time to watch it, are better suited to options trading than busy, beginner investors.

Brokerage firms screen potential options traders to assess their trading experience, their understanding of the risks and their financial preparedness. These details will be documented in an options trading agreement used to request approval from your prospective broker.

You'll need to provide your:

Investment objectives. This usually includes income, growth, capital preservation or speculation.
Trading feel. The broker will want to know your cognition of investing, how long you've been trading stocks or options, how many trades you make per year and the size of your trades.
Personal financial information. Accept on hand your liquid internet worth (or investments easily sold for greenbacks), annual income, total net worth and employment information.
The types of options you want to trade. For instance, calls, puts or spreads. And whether they are covered or naked. The seller or writer of options has an obligation to evangelize the underlying stock if the selection is exercised. If the author as well owns the underlying stock, the pick position is covered. If the option position is left unprotected, it's naked.

Based on your answers, the broker typically assigns you an initial trading level based on the level of hazard (typically 1 to 5, with ane being the lowest risk and 5 existence the highest). This is your central to placing certain types of options trades.

Screening should get both means. The broker you choose to merchandise options with is your well-nigh important investing partner. Finding the broker that offers the tools, enquiry, guidance and support yous demand is peculiarly of import for investors who are new to options trading.


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two. Pick which options to buy or sell

As a refresher, a phone call option is a contract that gives you the right, but not the obligation, to buy a stock at a predetermined cost — called the strike price — inside a sure fourth dimension period (Learn all nigh phone call options .) A put pick gives you the right, but not the obligation, to sell shares at a stated price before the contract expires. (Learn all virtually put options. )

Depending on which management you lot look the underlying stock to motion determines what type of options contract to take on:

If yous think the stock price will move up: buy a call option, sell a put option

If y'all think the stock price will stay stable: sell a call choice or sell a put option

If you lot call up the stock price will get down: buy a put choice, sell a call option

3. Predict the option strike price

When buying an option, information technology remains valuable only if the stock price closes the option'due south expiration period "in the money." That means either above or below the strike price. (For phone call options, it'southward above the strike; for put options, it's beneath the strike.) You lot'll want to buy an choice with a strike price that reflects where you predict the stock will be during the option'south lifetime.

For instance, if you think the share price of a visitor currently trading for $100 is going to ascent to $120 past some time to come date, you'd buy a call selection with a strike price less than $120 (ideally a strike price no higher than $120 minus the toll of the option, and so that the choice remains profitable at $120). If the stock does indeed rise in a higher place the strike price, your option is in the money.

Similarly, if you call up the company's share price is going to dip to $lxxx, y'all'd buy a put option (giving you the correct to sell shares) with a strike price above $80 (ideally a strike price no lower than $80 plus the price of the option, so that the choice remains assisting at $80). If the stock drops below the strike price, your option is in the money.

You can't choose just any strike price. Option quotes, technically called an pick chain or matrix, incorporate a range of available strike prices. The increments betwixt strike prices are standardized across the industry — for case, $ane, $two.50, $v, $10 — and are based on the stock cost.

The cost you pay for an choice, called the premium, has two components: intrinsic value and time value. Intrinsic value is the difference between the strike cost and the share price, if the stock toll is above the strike. Time value is whatever is left, and factors in how volatile the stock is, the time to expiration and interest rates, amid other elements. For example, suppose you accept a $100 call option while the stock costs $110. Let's assume the selection'southward premium is $15. The intrinsic value is $10 ($110 minus $100), while time value is $v.

This leads us to the final selection yous need to make before buying an options contract.

4. Decide the option time frame

Every options contract has an expiration catamenia that indicates the final day you can do the option. Here, too, you can't just pull a engagement out of thin air. Your choices are limited to the ones offered when you retrieve an pick chain.

There are ii styles of options, American and European, which differ depending on when the options contract can exist exercised. Holders of an American option tin exercise at any point up to the expiry date whereas holders of European options can only practise on the 24-hour interval of expiry. Since American options offer more than flexibility for the pick buyer (and more risk for the option seller), they usually cost more than their European counterparts.

Expiration dates tin range from days to months to years. Daily and weekly options tend to be the riskiest and are reserved for seasoned option traders. For long-term investors, monthly and yearly expiration dates are preferable. Longer expirations give the stock more than fourth dimension to move and time for your investment thesis to play out. Equally such, the longer the expiration period, the more expensive the option.

A longer expiration is also useful because the choice tin can retain time value, even if the stock trades below the strike price. An option's time value decays equally expiration approaches, and options buyers don't want to watch their purchased options decline in value, potentially expiring worthless if the stock finishes below the strike toll. If a trade has gone against them, they tin can ordinarily still sell whatever fourth dimension value remaining on the pick — and this is more likely if the option contract is longer.

NerdWallet editor Pamela de la Fuente contributed to this report.