This article will cover the basics of how to trade options. You will learn about the different kinds of options accounts and what is required to open a trading account. Then we will dive into the different option types you can trade and what it means to buy and sell these options. This article will give you the stock options basics so that you will have a great foundational knowledge of how stock options work.
Open a Trading Account
First things first, you will need a trading account if you want to learn how to trade options. You can obtain a trading account from an options brokerage. The brokerage firm will require some of your details to set up an account and each brokerage firm will have different requirements. Having a trading account will allow you to place trades. These trades will be initiated by your options broker.
What Type of Account Should You Open?
There are two main types of trading accounts: cash accounts and margin accounts. You will need to think about which type is right for you.
A cash account only allows you to use the cash in your account to pay for your trades. This means you will need to keep enough cash in your account to cover your investments. This can make your trading experience a little bit more difficult but a cash account forces you to think more about your trades and strategies.
A margin account allows you to use the assets in your account (the options you have already purchased) to finance your trades. This will allow you to make more trades than you would be able to with a cash account. This is similar to using a house as collateral to obtain a loan.
Do You Have Enough Cash to Start?
Options trading accounts will require a minimum deposit in order to open an account. There are a few factors that will influence the minimum deposit required. For example, the type of account you choose may have different minimum deposits. Margin accounts will require a higher minimum deposit than cash accounts. Also, different brokerage firms will require different minimum deposits.
Types of Brokerages
You will need to decide on whether you use an online brokerage or an offline brokerage firm. There are advantages and disadvantages to each type. One thing to keep in mind is that there are many variables in options trading that the broker will need to be clear for your purchases.
These variables are more easily communicated via an online brokerage firm. If you need to communicate these variables over the phone, or using another means of communication, then you run the risk of the broker misunderstanding. This could cost you money and needs to be avoided whenever possible.
Also keep in mind, that as long as you are relatively comfortable with technology, you should lean towards an online brokerage. Technology will continue to advance so you will have more options with an online brokerage. In general, online brokerages will be automated by computers. This means that online brokerages will have two main advantages over offline brokerages. The first advantage is that human error will be minimized, the second advantage is that you won’t be limited by the availability of human brokers.
Types of Options
Now that you know about brokerage accounts, let’s explore what you can trade with your new account. There are two types of options which are refered to as call options and put options. If you buy a call option, you are obtaining the right to buy stock at a set price anytime during a set period of time. If you buy a put option, you are buying the right to sell stock at a set price anytime during a set period of time.
You should also note that each option contract equates to 100 shares of stock. So, if you wanted the right to buy 1000 shares of stock at a later date, you would need 10 call options. If you wanted the right to sell 4000 shares of stock at a later date, you would need 40 put options.
Every time you buy a put or call option, you will pay a fee which is known as the premium. This is an important part of options trading as this is the most the person buying the options can lose. If you have a call option but the agreed upon price is higher than the stock market price, why would you use this option? The answer is you wouldn’t, you could just buy the cheaper shares on the stock market. The option would expire and you will lose the price you paid for the premium.
You may now be wondering, who gets the premium? The answer is the seller. We just spoke about buying call and put options but you can also sell these options. Instead of the right to buy or sell stock, the seller has the obligation to buy or sell stock if the person who bought the options chooses to exercise the options. For example, if you sell a call option, you are selling the right for the buyer to purchase stock at a set price during a set time period. You have the obligation to sell the required stock if the buyer exercises this option.
If you sell a put option, you are selling the right for the person buying the option to sell their stock at a set price during a set period of time. You have the obligation to buy the stock if the option holder decides to exercise this option.
Now you know the basics of how to trade options and should start learning about options strategies. You have learnt about different accounts and what it takes to open an option account. We have also covered the different types of options and now you have an understanding of what it means to buy and sell options. This is a great base in options trading basics to build your options trading empire!
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