Investment requires diversity. If you want to take your investment portfolio one step further than mutual funds, one leap beyond stocks, options trading is the way to go.
For the longest time, trading options has been hailed as a high-risk, high-reward type of trading, designated for experienced, seasoned investors only. That’s not the case at all; that opinion just comes from gatekeepers who don’t want you to know the true balance of options trading.
With the right know-how and some patience, anyone can trade options effectively. There is a higher risk than mutual funds, but the more you know about options trades, the better you can hedge those risks in your favor.
What is Options Trading?
Stock options are a financial derivative that exist at a set price, or strike price. Options are purchased through online retail brokers, similarly to stocks and futures, and buyers can refuse to sell those options if they do not agree with the price.
Options are dependent upon the specific contracts of said options, giving more power to the buyer, albeit with a higher associated risk and more information to know as opposed to stocks.
How Does Options Trading Work?
Similarly to selling stocks or crypto, you can use an online brokerage service to sell your options and cash in on your options gains. The terms are different from trading stocks, but at the end of the day, they are traded very simply.
What is a Put Option?
Buying a put option means having options with a specific expiration date or sell date in place. These are where people often think of gambling when it comes to trading options.
- Do you have enough money to do this?
- Will this ruin your investments if you lose out?
- What is the expected price movement? What’s the associated risk?
- What’s the longest time you can hold onto a put option without worrying or selling prematurely?
There’s more mental games to play when you buy put options, which is why this option is often (incorrectly) regarded as gambling, but it’s just playing the long game with strategic money moves in place.
If you purchase an option at a $100 strike price, and before the contract is up, the stock drops to $50 per share, you can exercise your contractual rights to sell that option at $100 before the expiration date goes into effect.
In reality, it can take a lot of the gamble out of doing this in the first place.
What is a Call Option?
Call options work in reverse, and there is more of a gamble here. You need to know the stock, know how it’s going to move (if only we all had a magic 8-ball for this), and invest in a call option that will allow you to buy those stocks at a discount when and if the price climbs.
The details are tricky and more than we can explain here right now. Call options are generally reserved for more experienced traders that can point out marks in how the market shifts and moves.
Call options are one of the most likely options that will sink a panicked seller.
What Should I Know Before Trading Options?
A few things. For one, you should never buy options on a whim. The entire principle behind financial gains with options trading is to make calculated risks. That means not spending your entire investment budget, and not putting all of your eggs in one basket (unless that basket looks really, really good).
You should understand all the options trading lingo and what different calls are, well, called! This is important to know before you hop into any investments. This will alleviate confusion and allow you to make your trades in a timely manner without having to pore over the small, negligible details.
Last but not least, options trading is a long-term strategy in most instances, so you want to do this with your long-term financial goals in place. If you are a panic seller, options trading may not be for you.
Are Trading Options Safe?
As safe as any other investment that depends on the way the market moves. There is volatility, and you have to weigh your risks before you begin an investment, but options actually offer more flexibility than other investment types.
There’s liquidity, securities, and the ability to diversify your portfolio with options trading. You need time to put into your market predictions, so if that’s not an option for you right now and you can’t commit a part-time schedule just to options trading (at the very least), you may need to consider diversifying your portfolio through other investment means.
Trading options isn’t for everyone, although many people—whether they’re new to investing or not—become well-versed in options and make a fortune in it if they’re intelligent, and don’t gamble money that they need.
For some investment types, it reduces risk, but it’s often viewed as a high-risk and high-reward investment strategy.
Should you invest in options? You should definitely diversify your investments portfolio, and if you do that effectively, you can use options as a means for short-term, large-scale gains (with proper strategy in place) while still having a comfortable and cushioned portfolio.
It’s something anyone can get into and learn about. Just make sure you have the time to commit to learning the ins and outs of options trading, as should be done with any investment strategy.
Options Trading FAQ's
It depends on your investment type and your portfolio. In most instances, options trading is considered more high-risk than stock trading, but if you can utilize market information, you can churn income on options trading.
There’s risk with both, of course. Stocks are something that you need intelligence and market analytics to read properly, but are most first-time investor-friendly. Options trading is something that, while anyone can get into, not everyone will be good with.
An options trader invests in options, which are contracts at the very base level. X amount of a stock has an expiration date and a strike price, and an options trader will essentially gamble that the stock will rise above the strike price, at which point gains become exponential.
However, they do run the risk of options timing out and being sold for bottom-dollar. It’s high-risk, high-reward, unless you’re able to understand the market more than your average investor.
It’s possible, but it’s not often going to yield a high return. Contracts exist to give an expiration date to the stock price, and it’s unlikely that your options are going to go above the strike price and exponentially increase in value in the course of a single day on the New York Stock Exchange.
However, day trading options is a real thing, it’s just very niche.
For the average investor, you can view options as a less risky investment than stocks—if you know how to read them.
Some options are only secured at a contracted price to offer some level of risk reduction for the company that the options refer to, allowing them to reduce risk and loss in the event that they aren’t able to reach that strike price.
Robinhood provides commission-free options trading on an intuitive platform. It is one of the best options trading platforms for beginners.