By Finley 
Traders often start their journey in the stock market. Buying and selling stocks is a straightforward process that can easily drive investment gains. Even those who are risk-averse can find strategies that allow them to participate.
Once traders gain experience, however, they may look for opportunities that provide higher potential for rewards. Options trading is one of those opportunities.
“Options trading amplifies earning potential,” says Fabio Ruggeri, Co-founder and CEO of MenthorQ. “It gives you more ways to make money without requiring that you put as much in. It also provides more flexibility than typical stock trading.”
Ruggeri is a fintech expert who has spent over 16 years developing skills in finance, investment strategies, and enterprise business development. He gained insights on modern finance while working with some of the largest banks, hedge funds, and asset managers in the US and Europe. Ruggeri founded MenthorQ to level the playing field in the trading space. The innovative trading platform gives retail traders the power to compete against institutional investors in the quantitative trading arena.
“But choosing to trade options also adds complexity to your investing,” Ruggeri warns. “Traders must ensure they have the knowledge needed for understanding options trading strategies before diving in.”
Key terms used in options trading, including types of options
Options are contracts that give investors the right to buy or sell an underlying asset without requiring that they follow through. An option contract sets the specific price and an expiration date before which the trade must be completed.
“Options open the door for traders to buy or sell without creating an obligation,” Ruggeri explains. “This allows them to limit their risk to the price paid for the option, which is known as the option premium, rather than the losses they can experience if they buy stock that ends up decreasing in value.”
Put options and call options are the two types of options that are traded. Where put options provide the right to sell shares at the stated price while the contract is in force, call options provide the right to buy. The price stated in the contract is the strike price.
Options are tied to an underlying stock or other asset. The fluctuation in the price of that underlying asset influences options traders’ behavior.
Key steps taken to trade options
Options trading is prompted by the belief that a stock’s value will move in a particular direction over a specific period of time. When traders feel the stock will rise, they will buy a call option that gives them the right to purchase at a price higher than the current price. If they believe the stock price will fall, they will focus on a put option.
Before an option contract can be purchased, traders must determine the strike price and expiration date. Once those factors are decided, traders can see what price they’ll need to pay for an option with those terms.
Options are generally purchased through a broker. Today’s traders typically use an online brokerage account for option trading. The account gives them access to option chains, which show the specific call and put options available at each strike price and expiration date.
“Option chains also show the current premiums for each option along with the volume of that type of contract that has been traded,” Ruggeri says. “Traders can also see the open interest on an option, which is the number of contracts not yet closed, settled, or expired.”
Traders use their broker to enter an order for the number of contracts they wish to buy. A single contract typically represents 100 shares of the underlying asset. Special instructions can include designating the order as a:
- Limit order, which specifies a maximum price the trader is willing to pay for the option.
- Market order, which buys at the current market price.
- Day order, which is automatically cancelled at the end of the current trading day if not filled.
- Good-til-Cancelled order, which remains active until executed or canceled by the trader.
Once all the details are determined and the order is submitted, the brokerage will attempt to match the trade order with another trader who can meet all requirements. If the trader is found, the order is executed.
Monitoring and exercising options contracts
The option trading process shifts to the monitoring phase after an order is executed. Traders will track the price of the underlying asset to see if it moves in the anticipated direction. They will also track the price of the option, which can be affected by factors including the price of the underlying assets, how volatile the security has been, and the time remaining on the contract. As the contract’s expiration date approaches, traders have a choice to make.
“If the option has gained value based on the movement of the underlying security, the trader might sell it to make money,” Ruggeri says. “If the trader has not seen the type of movement they expected, they might choose to let it expire worthless, which involves not exercising it and losing only the premium paid for the contract.”
The trader might also choose to exercise the contract before the option expires, which typically occurs when the price of the underlying security has risen significantly above the strike price, commonly referred to as being “in the money.” A trader exercises an option when they buy the underlying security at the strike price.
Beginner options trading strategies
Long calls and long puts are the most basic options trading strategies. They offer a great on-ramp for those looking to start trading options, in which traders can use options to increase their trading activity without adding complicated risk.
Long call option strategies involve buying an option on an underlying asset that you expect to increase. The profit potential for this type of option trading is virtually unlimited, while the biggest risk is that the trader will lose the premium.
Long put is a similar strategy used in option trading focused on securities expected to decrease in value. This approach doesn’t hold the same potential for return, but the maximum loss is also limited to the premium paid.
Selling covered calls is another basic strategy for option trading that beginners can easily engage in, which involves selling call options on underlying assets that you already own. Traders will engage in this strategy if they believe the underlying asset’s price will remain stable or increase slightly. For those who already own stock, this strategy can help generate income.
“As traders begin experimenting with option trading, paper trading can be an effective learning tool,” Ruggeri advises. “Essentially, paper trading involves using a virtual trading account to learn strategies and practice decision-making before engaging in a way that risks actual money.”
Developing a deeper understanding of options
Today’s traders have access to a wide variety of tools that can help them excel at options trading. Online educational platforms train traders on strategies to guide trading at all levels. They also allow traders to connect with communities of real-life traders and sit in on option trading sessions to see how actual trading activity unfolds. For those just getting started, those tools will be invaluable.
“Options trading can involve significant risk, which can lead to significant losses,” Ruggeri warns. “To avoid those losses, traders must start small, commit to learning, and avoid engaging in activity that reaches beyond their knowledge level.”