Want to learn how to trade stock options for beginners? Trading stock options can be a fun new challenge for seasoned investors or a way to manage your risk while starting out as a new trader.
Either way, you’re in the right place – in this complete guide, we’ll cover everything you need to know about getting started with this strategy. You’ll learn what exactly options trading is and what makes it an advantageous strategy. You’ll learn how to find stock options to trade, and how to set yourself up for success with your strike price and exercise date.
By the time you finish reading this guide on stock options trading for beginners, you’ll feel confident in your next steps to getting started and exercising your first options contract. Let’s start with some background information…
Is Trading Options Good for Beginners?
We are often asked – are trading options good for beginners? It certainly can be if you take the time to learn the ins and outs of this strategy and set yourself up for success. While options are more complicated than simple day trading or swing trading, you enjoy certain benefits – including the ability to take advantage of stock market movements without needing to own the stock outright.
Options trading is also great for bear markets or if you have a limited budget but want to speculate on certain stocks. Plus, with stock forecasting software like VectorVest, it’s easier than ever to find stock options that suit your risk tolerance and strategy. More on that later. First – what is options trading?
What is Options Trading?
Options trading is a strategy that involves the buying and selling of stock options contracts in order to speculate on stock prices. An option gives you the right but not the obligation to buy or sell shares at a certain price (the strike price) by a specific date (the exercise date).
You can choose whether or not to exercise this contract, depending on how stock prices have moved and your own goals for trading stock options. This is one of the benefits – as you limit your downside potential dramatically.
It’s important to understand the different types of options contracts, which are referred to as either puts or calls:
- Call options give you the right to buy stock at a specific price. The goal here is to purchase a contract for a stock you suspect will rise in price. You get a lower exercise price, and when the stock rises in value, you’re able to buy it at a discount and turn a profit.
- Put options give you the right to sell stock at a specific price. The goal here is to purchase a contract for a stock you suspect will fall in price. You get a higher exercise price, and when the stock falls in value, you’re able to sell it at a premium and turn a profit.
We have a complete guide on how stock options work if you’d like to learn more. For now, let’s address another common question we get – how much money do you need to get started?
How Much Money Do You Need to Start Trading Stock Options?
Fortunately, stock options trading does not require a large amount of money to get started. You can open an online stock broker account for as little as $100 and begin trading stock options with real money.
However, just be aware that when you start trading with little capital, you’ll earn little profits. At first, though, this is the recommended approach to help you work out the kinks in your strategy while keeping your relative risk low. We have a full guide on small account trading if you’d like to learn more. Now, it’s time to get into the real reason you came here – to learn how to trade stock options for beginners.
How to Trade Stock Options for Beginners: Step-by-Step Guide
Ready to learn about stock options trading? There are really only five steps to executing your first successful options trade. And after we explain how to trade stock options for beginners, we’ll provide two key insights on how you can really supercharge your chances of success. First, you’ll need to open a trading account if you haven’t done so already.
Open Your Trading Account
The first step in stock options trading for beginners is opening your trading account. Before you start trading stock options, make sure you set up an online brokerage account with a reliable provider.
Do your research to make sure you can trust the stock broker and that their trading platform is up to par with your needs. When comparing online stock brokers, it’s important to look at fees, research tools, customer service, stock ratings, and more. The specific brokerage you work with is not all that important – at least, not compared to how to find stock options to trade…
How to Find Stock Options to Trade: the Most Important Aspect of Options Trading for Beginners
This sounds obvious – but finding the right stocks to create options contracts for is paramount to seeing a high rate of success with this strategy. After all, trading stock options is about making informed, accurate guesses about how a stock price will move over a certain period of time. How do you actually go about finding these opportunities?
There are a few ways you can go about this. The first is technical analysis – where you’ll rely on complex technical trading indicators like moving averages, candlestick charting, and stock price oscillators to help you make educated guesses about stock prices. You’ll want to look at these indicators through different time frames to get the full perspective. These will help you identify trends early on and assess how a stock may perform over the course of a few weeks, months, or even a year.
The other method requires you to do some research into a company and make an informed guess as to how the stock will perform based on the news you uncover. Did a company just make a big acquisition of another company? Chances are, the valuation will rise over time. Did a company just get hit with a lawsuit? Chances are, the valuation will fall over time. You can also take into account market sentiment – in other words, how the market as a whole feels about a stock. After all, market perception typically becomes reality.
You can rely on a combination of these analysis tactics to find opportunities. However, there is actually a quicker, more foolproof approach to uncovering and assessing opportunities in the stock market. We’ll talk about that later. First, let’s talk about determining your strategy once you’ve found an opportunity.
Determine Your Stock Options Trading Strategy
As mentioned earlier, there are two main types of stock options: call options contracts and put options contracts. It’s imperative that you understand the difference between these and choose the right one based on the opportunity you’ve uncovered.
But, taking things even a step further, there are different approaches you can take to either type of contract. This may be getting a bit too far from what a beginner to trading stock options needs to know to get started, but you’ll want to leverage these different strategies at some point in time.
- Long Calls: This one is pretty simple – you expect the stock price will exceed the exercise price by the exercise date. In other words, the stock is going to rise in value from where it sits today. You’ll earn unlimited upside potential if your theory proves true.
- Long Puts: This strategy is also straightforward and is exactly the opposite of the long call. With a long put, you expect the stock price will fall below the exercise price before the exercise date. There is less upside potential to this strategy, as the stock can never go below $0. With that said, it’s a great strategy when stocks are way overvalued.
- Covered Calls: Rather than buying a call option, a covered call involved selling a call option. This is known as a short call – however, the covered call has a twist to help manage risk. You’ll also buy the underlying stock in question. This is a strategy you would use if you already own the stock in question and don’t expect it to rise much in value – but still want to generate some additional income while maintaining your position.
- Covered Puts: Another way you can manage risk with stock options while generating additional income is a covered put. This is very similar to the covered call, only you’re taking the opposite stance. You own the underlying stock in question and expect it will rise in value. By purchasing a covered put, you’re hedging your bet in case the stock ends up falling in value. You’ll earn less profit here, but you also manage your risk.
- Short Puts: Finally, you have the short put. Here, you are betting that a stock’s price will rise above the exercise price before the exercise date. This is a relatively safe strategy when you don’t expect a stock will fall in price, but your upside potential is limited to just the premium of the contract.
Predict the Strike Price & Choose Your Exercise Date
No matter which strategy you go with, it’s important to weigh the strike price and exercise date. Getting these dialed in influences the profit potential you have along with the risk you expose yourself to.
The closer your strike price is to the current price of a stock, the less valuable it is – as your profit potential is lower. However, your risk is also lower. Here’s an example to illustrate this relationship better:
Say you have a stock trading at $100. You expect it’s going to rise in value – so you’re seeking a long-call contract. A strike price of $110 means the value has to raise $10 for your contract to be in the money – which is fairly attainable depending on the exercise date in question. However, you’ll get far better value from a more aggressive strike price – say, $150. With that said, your likelihood of seeing that contract play out favorably is lower. You’ll have to weigh your own risk/reward tolerance in choosing your strike price.
Similarly, you need to consider the exercise date – which is the point in the future at which you’ll either have to exercise your options contract or sell it. After this date, the contract is worthless. Contracts with shorter exercise dates are more affordable as you have less time to see the stock price move into the money. Contracts with longer exercise dates are more expensive, but give you more time to see your vision come to fruition. Again, it’s a balance between risk, reward, and profit potential.
Manage the Position Over Time & Exercise the Options Contract When it’s in the Money
Once you’ve purchased your stock options, it’s just a matter of managing the position and hoping for the best. You’ll manage your position over time, and ideally, exercise the contract when you’re in the money – earning a nice profit along the way.
But what if your exercise date is rapidly approaching and your position is out of the money? There are two approaches you can take to manage the contract.
You can sell it for whatever you can get on the market – knowing that you won’t get the full value you paid, but cover some losses from the premium of the contract.
Or, you can hold out and see what happens – and if you never get in the money, simply let the contract expire. You’re only out the premium you paid for the contract.
How to Get the Highest Rate of Success With Stock Options Trading
There you have it – how to trade stock options for beginners. As you can see, stock options trading is a bit more complicated than swing trading for beginners. However, it’s worth the extra time and energy – as you can earn unlimited upside potential while minimizing your risk.
Hopefully, this detailed guide on getting started helps you feel more confident and comfortable. Before we bring this guide to a close, we want to give you two more invaluable pieces of advice to increase your rate of success:
Take the Time to Learn & Practice Trading Stock Options
Just as you should learn swing trading before making your first swing trade, take the time to fully understand options before purchasing your first contract. We have courses on our site that can help you gain a deeper understanding of how these strategies work. It’s worth the cost to speed up your learning curve and increase your profit potential once you start trading.
If nothing else, explore our blog where we cover additional topics related to stock options. You can learn about taxes on options trading, when to exercise options, swing trading options, and risk management for options trading. We also have guides comparing stock options trading to other strategies:
However, if you only took one piece of advice away from this article, let it be this…
Get Tools to Help You Pick Options Contracts & Exercise Them at the Perfect Time
When it comes to buying stock contracts, it’s worth investing in tools that increase your chances of success and save you time. And one of the best tools for that is VectorVest: the #1 stock analyzer software on the market.
VectorVest uses a proprietary stock rating system that speeds up the process of uncovering opportunities in the stock market – while eliminating human error, emotion, and guesswork from your strategy. It tells you exactly what to buy, when to buy it, and when to sell it. Think about how simple trading stock options could be with powerful software that does all this – and a whole lot more!
The system has outperformed the S&P 500 for decades, and it can help you do the same in your portfolio – no matter what investing strategy you employ. You can even take it on the go with you through our mobile stock advisory. See what it looks like in action through our free stock analyzer today.
Final Thoughts on How to Trade Stock Options for Beginners
That brings our guide on how to trade stock options for beginners to a close. We hope you feel empowered to start trading stock options yourself after reading this. Whether you’re an experienced trader looking for a way to hedge risk or a new investor not sure where to start – options can align with your investment goals.
And with the help of VectorVest, you can hit the ground running at a high rate of success – enjoying profitable trading on a consistent basis. After all, VectorVest is more than just the best platform for swing trading!
So – what are you waiting for? Put all this into practice today!