How to Trade Options: A Basic Guide | The Motley Fool

Options contracts are fiscal instruments that savvy investors can use to adjust the excitability and risk profile of their portfolio. Used prudently, they can help you meet your investment objectives whether you ‘re looking to maximize the measure of your portfolio ( at the hazard of greater losses ), conserve its prize, or generate extra income. But if you do n’t know what you ‘re doing while trade options, you may end up losing a fortune of money .Smiling adult raises hands in celebration while seated at desk in front of laptop.
image source : Getty Images .

How options work

An choice is a shrink between two parties that gives the sign holder the right, but not the obligation, to buy or sell shares of a stock at a specify price on or before a stipulate date.

The choice ‘s specified price is called the strike price. The date on the choice is its exhalation date. The monetary value you pay for the contract is called the agio. Options derive most of their prize from the stock they ‘re associated with. The stock certificate price relative to the choice strike price is the chief determinant of their value. As such, they belong to a classify of fiscal instruments called derivatives. There are two types of options contracts. Calls give the narrow holder the proper to buy shares at the mint monetary value. Puts give the contract holder the right to sell shares at the hit price. Each contract is for 100 shares. Calls and puts with diverse strike prices and expirations barter every day the stock market is open. You can trade options with strike prices close to the current stock price or identical far off from the strike price. You can trade contracts for future week, next month, next year, or more than two years away .

Understanding how to read options tables

When you go to trade options, you ‘ll find a postpone of contracts for any given passing date. here ‘s a dowry of the table for Apple ( NASDAQ : AAPL ) call options expiring about a calendar month from the time this was written in August 2021 when shares traded at around $ 148.50 .

Strike Price Last Price Bid Ask

$23.51 $23.55 $23.65
$130 $18.75 $18.75 $18.85
$135 $13.97 $13.95 $14.10
$140 $9.60 $9.60 $9.65
$145 $5.82 $5.80 $5.85

$150 $3.06 $3.05 $3.10
$155 $1.39 $1.40 $1.41
$160 $0.61 $0.60 $0.61
$165 $0.29 $0.28 $0.29

Data source: Yahoo! Finance. Data current as of Aug. 5, 2021. The first gear column shows the assorted hit prices available for the assign exhalation date in September. The second column shows you the end price the contract traded for. note that you wo n’t necessarily be able to trade a compress at that price. Bid and ask prices are adept indicators of the price for a craft you ‘re trying to execute right nowadays. The bid price is the highest measure anyone in the market is volition to spend to buy the condense. The ask price is the lowest sum anyone is bequeath to sell the contract for .

How to trade options

Open an options account

Before you can start trade options, your broker has to approve you to do then. You ‘ll fill out a questionnaire detailing your investing experience, how frequently you trade, your income, internet deserving, and at what level of complexity you ‘d like to trade. Based on your answers, your broke may grant you the ability to trade options at any horizontal surface up to your requested flat. If you do n’t get approved for your requested level right away, you ‘ll have to trade in the restricted account for a while and reapply. note that some retirement accounts have restrictions on what kind of options trades are possible. For exemplar, you can not use allowance in an individual retirement report ( IRA ), so you can not sell put options without adequate cash in the account to cover the trade in case the contract holder exercises the choice and forces you to buy shares.

Pick a type of option to trade

There are a bunch of choices when it comes to options and a batch of ways to piece contracts and stocks together to make a trade. The simplest trade is buying a call or put option. The first thing to do is analyze a company, upcoming events such as big announcements or earnings releases, and determine whether shares are overvalued or undervalued. If you believe shares are undervalued, buy a address choice expiring at some indicate in the future when you think the commercialize will realize the truthful measure of the shares. If you think they ‘re overvalued, buy a arrange option. Earnings and bad events can be catalysts for major stock price changes .

Determine your target strike price

If you ‘re buying an options contract, you want it to be worth something as it approaches exhalation. If the fall price on a call option is less than the sprout price, it has intrinsic value. You could exercise the choice, buy shares at the stock monetary value, immediately sell them at the higher stock price, and make a profit. Likewise, put options have value if the hit price is higher than the actual plowshare price of the neckcloth. In determining your target strike price for an option, you want to balance risk versus reward. You can maximize reward by buying contracts that presently have no intrinsic prize ( called “ out of the money ” ) with the expectation that they will gain value by the termination date. You can minimize hazard by buying options that already have intrinsic value ( called “ in the money ” ). Out-of-the-money options have lower premiums than in-the-money contracts. Another risk lever is based on the passing date. The more time until termination, the more opportunities the broth has to move in the direction you expect. As a solution, options contracts with termination dates further out can be less hazardous than those expiring in good a few days, and, therefore, they carry higher premiums .

Make your trade

Select the options contract you ‘d like to trade. Pay the premium and any commission to your broker, and take ownership of the narrow. In practice, it ‘s unlikely you ‘ll exercise the options contract. If you made a profitable deal, you can sell the option for a gain before passing. If the choice expires despicable, there ‘s nothing to be done.

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Risks in options trading

Options trades typically have well-defined loss risks. For model, if you buy a predict or put option, the most you can lose is the premium you paid for the choice. That happens when the option expires worthless. If you sell a place choice, the most you can lose is the affect price of the abridge multiplied by 100 for each contract you sold. That ‘s offset by the premium you collect from primitively selling the plowshare. This entirely occurs if the stock goes to $ 0 per plowshare before your contract expires. You ‘d be forced to buy despicable shares at your affect price. however, if you sell a call option, you potentially face unlimited losses. The stock price can go up to eternity, and you ‘ll be on the crochet for selling shares well below their grocery store value. It ‘s the like risk as shorting a stock, but since options provide extra leverage, the likely losses are magnified.

There are ways to mitigate the risks in options trade. In fact, many options trade strategies are used to minimize risk by combining contracts or shares of the underlying stock. It can pay to educate yourself further about those strategies in order to fully understand the risks involved with deal options before you put very money on the line .Adam Levy has positions in Apple. The Motley Fool has positions in and recommends Apple. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy

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