Would you like to learn stock options trading but don’t know where to start?
Well we’ve got your back and designed this step by step guide on how to educate yourself in the art of in trading options.
(Oh, and we’re sorry for calling you a dummy…).
Learn Stock Options Trading
Step 1: Learn How Options Work
Before learning the tools of the trade – the strategies and tactics traders employ – you need to know some of the theory of options.
Don’t worry, you don’t need a degree in advanced mathematics. But you do need to know how options are designed and some of the key terms.
In particular you should understand:
- what call and put options are
- what is meant by an option’s strike price.
- how to read an options chain.
- what is implied volatility
- what is meant by in the money/out of the money options
- the role of an options broker
We’ve put together a post to help you to learn these important parts of how options work here
Step 2: Understand The Options Greeks
The next important lesson is to learn all about the options ‘greeks’.
Named after greek letters, these describe how an option’s price is effected by the movement of an important variable:
- Delta: How options price moves with changes to the underlying (usually a share price, but not always)
- Gamma: How delta changes with changes in price to the underlying
- Theta: How options prices change over time
- Vega: How options’s prices change with expectation of future volatility (or implied volatility)
- Rho: How changes in interest rates change options pricing
We have a more detailed guide on the options greeks here.
Step 3: Learn Some Basic Options Strategies
The are a few basic strategies to start out with. For each strategy its important to know when to put them on – what are you looking for?
(Actually, as you will discover, a better strategy is to work out what you think will happen to an underlying and then find a strategy to match).
The first two simplest strategies are the buying of a call or put option (the first of which is explained in more detail here).
Then you’ll want to look as some basic options spread strategies. We’ve covered these in more detail elsewhere but in summary you should start with the following spreads:
- Vertical Call and Put Spreads
- Involves the buying of a call/put at one strike price and the simultaneous sale of the same type (call/put) at a different strike price.
- Often a cheaper and or less risky way of benefiting from stock movements than buying or selling just one option.
- The main strategies to learn are the bull call spread (see here) and bear put spread (covered here).
- Covered call
- The sale of a call option (usually) at a strike price higher than the stock price, whilst simultaneously owning the underlying share.
- More details can be found here.
- Calendar Spread
- Involves the purchase of a long dated option followed by the sale of a shorted dated one at the same strike price and pver the same underlying.
- Unsually placed at the money (ie the strike price chosen is close to the stock price) to take advantage of time decay (the spread is positive theta and will increase in value over time) when the stock price is not expected to move significantly.
- See here for more details on calendar spreads.
Step 4: Open an Options Broker Account
Options brokers, often owned by stockbrokers, facilitate the purchase and sale of stock options.
We’ve covered them in more detail here.
Once you’re up and running with an account you should practise trading using ‘paper trading’ (ie ‘pretend’ trading using nominal money rather than real cash – most brokers offer this facility).
Step 5: Trade With Real Cash
However good trading with ‘paper’ money you are, there’s no substitute for using real hard cash to trade.
Deposit a (small) amount – one that you can afford to lose – into your broking account and trade. This is where you really learn how to trade options.
Step 6: Keep Learning
Keep reading and trading and persevere. In no time you’ll be trading like a pro…