Trading stock options can be more complex than stock trading. When buying a stock, you decide how many shares. Then your broker fills your order using the current market price or your set limit price. Options trading requires a good grasp of advanced strategies, and the opening process of an options trading account includes a few more steps than opening a typical investment account.
4-Step Trading Option Process:
1. Open an options trading account
The capital for options trading is much larger than the usual brokerage account, so do a lot of research to cover all bases. To approve and greenlight a potential investor, brokers need to investigate several high-risk factors before allowing them access to a permission slip to start trading options.
Before approval is given, the brokerage firm screens the applicant to assess their financial readiness, trading experience, and risk understanding. These will be in an options trading agreement and will be reviewed thoroughly by prospective brokers.
As an applicant, supply the brokerage firm with:
Investment objectives – income details, capital preservation, growth, or speculation.
Trading experience – your investment knowledge, your experience in trading stocks or options, the number of annual trades made, and the size of those trades
Personal financial information – your liquid net worth (your investments you could easily sell for cash), employment information, total net worth, and annual income.
Preferred options – what kinds of options you’re interested in- trade puts, spreads, or calls. Determine if you want them naked (unprotected) or covered (protected).
2. Select which options to buy or sell
An option contract provides the right but not the obligation to buy (call option) or sell (put option) shares at a set price or strike price within a specific period.
The type of option chosen will depend entirely on your forecast direction of the underlying stock.
If you think the price of a certain stock will:
- Go up, buy a call option and sell a put option.
- Be stable: sell a call or put option.
- Diminish in value: buy a put option, sell a call option.
3. Predict the option strike price
Buying an option will only remain valuable if the stock price closes “in the money” either above or below the strike price. Call options should be above the strike price, while for put options, below the strike price. Aim to buy an option with a strike price reflecting your forecast of where the stock will remain during the options’ lifetime.
4. Establish the option time frame
All options contracts have a predetermined expiration period which determines the last day to exercise the option. As an option holder, choose the ones offered when you do call up an option chain.
Expiration dates differ in options trading, ranging from days to months or even years.
Although the longer expiration periods typically cost more than the daily or weekly options, this will allow the stock to move more and may result in having your investment plan play out.
Option trading requires more experience and more capital than regular investments. It follows a 4-step process to get started on options trading, beginning with opening an options trading account. When done right, option trading can be as rewarding as stock trading.