If you’re looking for an alternative to trading stocks then perhaps options trading is worth a look. You can go down the traditional method of using a stock broker to buy options. If you have one you trust already then it makes sense. If you don’t or if you fancy getting a service which is a little better suited to what you’re trading in then you can go for an online options trading broker. There are literally thousands of them but I just used the same broker for both types of investments. Distinct advantages exist for trading options rather than stocks so it’s well worth investigating. This brief description is intended to be a quick guideline to get you started. Think of it as an options trading for dummies tutorial. It is not difficult to trade options, but certain pitfalls have to be avoided. At stocks for beginners I’ll try and save you that hassle.

Options Trading For Dummies

As with any kind of stock investing there are sites online that let you give it a try first in a fantasy stock market scenario. Several online brokers offer demo accounts where you can play around and get comfortable in this world. This is a good way to learn options trading without having to commit real money so I would recommend you try it out before getting out your credit card. I’m assuming you’d have learned that lesson from reading about the stock market for dummies.

So on to the basics! There are two types of options, a put and a call. A call is the right to buy a stock at a certain price by a certain date. A put is the right to sell a stock at a certain price by a certain date. However, there is no obligation to sell or buy the underlying security. The advantage of an option over a stock is that one option contract controls one hundred shares of stock at a fraction of the price. The disadvantage is that the option expires on a given date at which point it is either exercised or expires useless.

The first step in trading options is to find an option chain. This can usually be done at an online broker by selecting “trade option” and putting in a stock symbol, then requesting the option chain. The basic chain includes: strike price, bid price, ask price, last price, volume, and open interest.

The strike price is the price at which the security will be purchased (in the case of the call), or sold (in the case of a put). A strike price can be: in the money (ITM), which is less than the current security price, at the money (ATM), equal to the stock price, or out of the money (OTM), greater than the underlying security price.

The bid price is what a buyer is willing to pay for the option. The ask price is what a seller is willing to sell the option for. The difference between these prices is called the spread. Spread trading was covered in an earlier post so check that out if you’re interested.

The expiration date of an option is another element of the price. When the chain displays it usually lists options with expiration dates within the next three months. Option expiration takes place on the third Saturday of each month. Since Friday is the last trading day of the week, the last opportunity to exercise an option is the Friday before expiration day.

The price of the option is made up of two components: intrinsic value and time value. Intrinsic value is determined by the price of the underlying stock. The time value is determined by its time to expiration. Intrinsic value will increase or decrease along with the stock price. The time value decays as the expiration date approaches. Sounds a bit tricky if you’re just learning about how to buy and sell shares online.

There are differing strategies regarding trading options, i.e., whether to trade ITM, ATM, or OTM, and what expiration date to choose. Which of these strategies to use, and how to decide the best methodology, is something that should be studied before jumping into online options trading. As with anything money related, make sure you are comfortable in the market before risking any cash. Fantasy stock market scenarios are ideal for this. I’d even recommend doing this before you sign up for any of the penny stock brokers you’ll find online.