What to know before starting to trade options: A 2023 guide

It’s 2023, and maybe it’s finally time to start establishing an investment portfolio. With some digging and everything from the definition of the stock market to passive income figured out, at some point, one is likely to stumble across an asset class called “options”. It sounds intriguing, but without much knowledge about it or the trading strategies behind it, it’s not very useful! 

Luckily, this post will explain what options are, why they might be preferable to trade instead of direct assets, and the common options trading strategies that beginners are most likely to follow. 

Options: What are they, anyway?

Options are contracts that an investor can either purchase or sell at a fixed price over a fixed period. An option’s underlying asset can be anything from a stock to a commodity to an index, and they’re called options because one can – but doesn’t have to – purchase or sell them whenever the contract expires.

There are three option types:

• Call options: These are contracts that allow traders to purchase shares (typically in increments of 100) over a predetermined duration. It’s worth purchasing these if it looks like stock or security is about to become more valuable. The point behind buying call options is to profit from their eventually higher value once they are sold.

• Put options: These are pretty much the opposite of call options since they let traders sell a particular number of shares over a predetermined period. They have to pay attention to the strike price to see if it gets higher so that they can make a profit – a higher strike price means the option is more valuable. If one is going to purchase put options, the value of the shares or security should down.

Why trade options vs direct assets

Trading options allow make it possible to avoid working exclusively with direct assets, which, while potentially valuable for a beginning investor, can limit the diversity of an investment portfolio. By trading options, novices can get their feet wet with ETFs, stocks and indices – plus, there’s a chance to play around with a tonne of trading strategies. Options trading strategies can be pretty straightforward or mind-bogglingly complicated and everything in between. This is a good thing because it means that these strategies are attractive to investors with different levels of experience.

Options trading strategies for beginners

Trading options can initially seem intimidating since one is doing more than simply working with the stock market. And options trading can appear much more complicated than it is if approached without a concrete strategy. By learning different investment methods, one can trade options successfully while avoiding headache-inducing confusion.

Below are a couple of basic trading strategies to follow if for those new to trading options: 

• Purchasing calls 

Buying calls – sometimes referred to as “long calls” – is smart if the trader is confident about an index’s or stock’s price. Purchasing calls lets them pounce on a stock’s increasing value, and it can mitigate investment risk as a beginning trader. The loss potentially experienced when purchasing calls is limited only to how much is paid for a contract; the profit is potentially unlimited as long as the shares continue to increase in value.

• Purchasing puts

This one’s pretty similar to purchasing calls, the difference being that the trader is going to watch for assets becoming less valuable rather than more valuable. Using this strategy is good for those not too keen on short-selling, since the risk associated with purchasing puts – or “long puts” – is a lot less significant. There’s really only a risk to the premium’s value when purchasing puts in the event the asset goes higher than the starting strike price. For anyone looking for a low-risk way to pounce on decreasing asset values, this strategy could be the best bet.

Shorting puts

Shorting puts is a beginner-level strategy for newcomers and traders who want to get into options selling. The “short put” strategy is for people who want to profit from the premiums they paid when first purchasing their options contracts. So, if one investor wants to leverage a short put strategy and connects with another investor to sell put options, that second investor will allow the put contract to expire if the value of the sold shares grows or remains the same. The initial investor would hold onto the premium once the contract has expired and, therefore, make a profit off the resulting transaction.

• Bonus strategy: trading real estate options

The real estate market is huge and complex, but it’s also one to take advantage of once one is comfortable with options trading. Real estate options have a specific buy price and are valid anywhere between six months and a year. Traders purchase a premium to enter into a contract for real estate options that, rather than being sold on exchanges, are specific to a single property (and occasionally multiple properties). They can exercise real estate options before or on their expiration date and sell them to other investors.

How to start trading options

Before diving into options, it’s necessary to have a good understanding of what options are, how to trade them and the risks involved. For those completely new to investing, it’s best to begin by using an online stock market simulator to practice trading without any financial risk. 

Then, confidence and know-how is built, and the novice trader is ready to start options trading, they should sign up for a broker like Fidelity or JP Morgan. It’s a good idea to start small and use beginner-friendly trading strategies while focusing on an asset one knows well – one can always try more advanced options strategies as experience grows.

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