How to Start Trading Options

The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.

In the past, mainly professional traders traded options. The reason was simple — amateur traders were often mystified by the amount of potential risk involved in some variations of options trading.  

As defined by the U.S. Securities and Exchange Commission (SEC), options are contracts giving the purchaser the right — but not the obligation — to buy or sell a  security at a fixed price within a specific period of time. Options derive their value from underlying assets, including stocks, stock indexes, exchange-traded funds, fixed income products, foreign currencies, or commodities.  

Transactions generally require less capital than equivalent stock transactions. Options allow the investor to participate in a stock without actually owning it and whose price could rise, fall, or remain the same by a certain point in the future.  

There are many stories about how much money someone has made, or lost, trading options. Today, the three most common uses for options are speculation, income, and protection. Therefore, it is essential to have a few terms explained so certain investors can explore this type of trading. In the end, options trading can be more available than you think. 

What are Options? 

Options are essentially conditional derivative contracts that allow investors to speculate the future of an asset’s price at a certain point in time without actually buying the asset.  

A derivative means that the value is derived from another asset. For example, in stock options, price, moneyness, and duration (time to expiration) generally determine the value of an options contract. 

There are two types of options: “call” and “put” contracts. Calls provide the holder the right to buy the stock at the strike price on or before expiration. It obligates the seller to fulfill their side of the contract, which is to sell at the strike price if assigned. Put contracts provide the holder the right to sell the stock at the strike price on or before expiration and obligates the seller to fulfill their side of the contract, which is to buy the underlying stock at the strike, if assigned.

Calls and puts move in opposite directions, kind of like traffic on a two-way street. So in general, you can buy calls when you think the underlying stock will go up or buy puts when you think it’ll go down. 

Another essential element is the expiration date. The owner of a contract has the right until the contract’s expiration date to either let it expire worthless, sell it back into the market or exercise at a predetermined price known as the strike price. 

There are many strike prices. Since options are contracts, if exercised, “call strikes” lock in a buy-price of the stock and “put strikes” lock in the sell-price of a stock.  

Most options traders close their position before it reaches its expiration date. 

Additionally, the price required to purchase such an option is called a premium, and it’s calculated based on several factors that include: the underlying security’s price in relation to the strike price, the length of time until the option expires, and how much the price fluctuates. 

It is also essential to consider that the intrinsic value is the difference between an options contract’s strike price and the current price of the underlying asset. Only in-the-money options have intrinsic value. 

The extrinsic value represents other factors outside those considered intrinsic value that affect the value of the option. Generally, a contract loses value when it is near its expiration date because there is a shorter time for the underlying security to potentially move in its favor. 

Another critical factor influencing extrinsic value is implied volatility, which measures the amount an underlying asset may move over a specified period. If the implied volatility rises, the extrinsic value will grow. 

In-the-money or Out-of-the-money 

There are many strikes above and below the underlying stock price — the further away  from the stock price, the more expensive or cheaper the options can get depending on  whether they are “in the money” or “out of the money.” 

Depending on the option type, and where the underlying security’s price is in relation to the strike price, an option is said to be in-the-money or out-of-the-money. A call contract is in-the-money when its strike price is less than the current underlying stock price. A put contract is in-the-money when its strike price is greater than the current underlying stock price.

It is essential to highlight the importance of knowing how the value of an option contract can change as the underlying stock moves. The very deep-in-the-money options may change nearly dollar-for-dollar with the underlying stock. In contrast, the far out-of-the-money options will generally move more slowly. 

Why Consider Options? 

Options allow you to be bullish on investments you believe in and bearish on the ones you don’t. In addition, they can be a powerful financial tool that enables you to build strategies ranging from buying or selling a single option to very complex ones that involve multiple, simultaneous option positions. 

Options are a form of leverage that can potentially offer investors better returns, time to see how things play out and some protection from downside risk. However, options are also complicated, risky investments and not appropriate for everyone.  

The Future of Options Trading is Here 

In the past, you generally needed a broker to start trading, and this could translate into high fees and account minimums.  

Three years ago, Robinhood Financial LLC started to offer a commission-free* and intuitive options trading experience to eligible investors. 

The company is constantly enhancing its options product designed to help make the trading experience even better.  

Additionally, Robinhood offers an Options Trading Essentials hub and a dedicated site on Robinhood Learn featuring regularly updated educational resources.  

While we can’t promise that learning about options will make you a successful trader, it can help you become a more aware trader. 

Options trading entails significant risk and is not appropriate for everyone. Individuals must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount.  Investors should consider their investment objectives and risks carefully before investing in options. Supporting documentation for any claims, if applicable, will be furnished upon request. 

All investments involve risk and loss of principal is possible. Any contents provided are for informational purposes only, do not constitute investment advice, and are not a  recommendation for any security or trading strategy. 

Robinhood Financial LLC (member SIPC), is a registered broker-dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides cryptocurrency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’). © 2021 Robinhood Markets, Inc.  

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.