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Top 3 Options Trading Strategies for Beginners
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Trading options is very different from trading stocks because options have distinct characteristics from stocks. Investors need to take the time to understand the terminology and concepts involved with options before trading them. Options are financial derivatives, meaning that they derive their value from the underlying security or stock. Options give the buyer the right, but not the obligation, to buy or sell the underlying stock at a pre-determined price.
Our opinions are our own. Options trading can be complex — even more so than stock trading.
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When you buy a stock, you just decide how many shares you want, and your broker fills the order at the prevailing market price or a limit price you set. Trading options requires an understanding of advanced strategies, and the process for opening an options trading account includes a few more steps than opening a typical investment account.
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See all the differences between stocks and options here. Need to brush up on puts, calls, strike prices and other options trading lingo?
See our post on options trading Compared to opening a brokerage account for stock trading, opening an options trading account requires larger amounts of capital.
And, given the complexity of predicting multiple moving parts, brokers need to know a bit more about a potential investor before awarding them a permission slip to start trading options.
4 Replies to “Options Theory: How to Make a Pure Volatility Bet Part 1”
Brokerage firms screen potential options traders to assess their trading experience, their understanding of the risks and their financial preparedness. This may include income, growth, capital preservation or speculation.
Trading experience. Personal financial information. Have on hand your liquid net worth or investments easily sold for cashannual income, total net worth and employment information.
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The types of options you want to trade. Options bets on your answers, the broker typically assigns you an initial trading level typically 1 to 4, though a fifth level is becoming more common that is your key to placing certain types of options trades.
Screening should go both ways.
The broker you choose to trade options with is your most important investing partner. Finding the broker that offers the tools, research, guidance and support you need is especially important for investors who are new to options trading. Decide which direction you think the stock is going to move This determines what type of options contract you take on.
As a refresher, a call option is a contract that gives you the right, but not the obligation, to buy a stock at a predetermined price called the strike price within a certain time period. A put option gives you the right, but options bets the obligation, to sell shares at a stated price before the contract expires.
If the stock does indeed rise above the strike price, your option is in the money. If the stock drops below the strike price, your option is in the money. Option quotes, technically called option chains, contain a range of available strike prices. The price you pay for an option, called the premium, has two components: intrinsic value and time value.
Intrinsic value is the difference between the strike price and the share price, if the stock price is above the strike.
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Time value is whatever is left, and factors in how volatile the stock is, the time to expiration and interest rates, among other elements. This leads us to the final choice you need to make before buying an options contract.
In our third installment we are going to focus on how to sidestep direction and bet instead on volatility. Namely, direction, speed, and magnitude.
Determine the time frame in which the stock is options bets to move Every options contract has an expiration date that indicates the last day you can exercise the option.
Your choices are limited to the ones offered when you call up an option chain. Expiration dates can range from days to months to years. Daily and weekly options tend to be the riskiest and are reserved for seasoned option traders. For long-term investors, monthly and yearly expiration dates are preferable.
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Longer expirations give the stock more time to move and time for your investment thesis to play out. If a trade has gone against them, they can usually still sell any time value remaining on the option — and this is more likely if the option contract is longer.
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About the authors: James F. Royal, Ph. Read more Chris Davis is a NerdWallet investing writer.
He has more than options bets years of agency, freelance, and in-house experience writing for financial institutions and coaching financial writers. Read more On a similar note