How to Buy Options: A Step-by-Step Guide

Options, Strategies
how to buy options: woman using a computer

Historically, options were viewed as an advanced instrument that retail investors weren’t supposed to touch. Today, opinions have changed and now options trading is more popular than ever. It’s no longer hard to buy stock options as most stock brokerages offer them. That’s great news because the more tools you have in your investment toolbox, the faster you’ll be able to build a retirement portfolio or reach other financial goals.

In this article, we’ll briefly review the risks and benefits of options as well as the main options trading strategies. Then, we’ll dive into how to buy options. 

Put Options and Call Options 

First, let’s get clear on the key terminology that any options trader should know. 

There are two types of options contracts: 

  • Put options: This is a derivative that gives you a right to sell shares at a specified price. As an options holder, you profit if the stock price falls. 
  • Call options: It gives you a right to buy shares at a specific price. If you hold this option, you profit when the stock rises.

Every options contract has several key characteristics: 

  • Underlying security: This is the stock or ETF your option gives you the right to buy (for calls) or sell (for puts).
  • Strike price: This is the stock price at which you can exercise the option and buy or sell the underlying asset.
  • Expiration date: This is the date by which you can exercise the option and after which the option becomes worthless.  
  • Option’s premium: This is the price you pay to buy an option. There is usually a spread between the ask (the premium, or the price at which you can buy the option with a market order) and the bid (the current price at which you can sell the option).

Now that we got the main terms covered, let’s take a brief look at options trading strategies you can use. 

Options Trading Strategies

how to buy options: man using his laptop

With stocks, you basically have two courses of action: buy the stock if you’re bullish or short sell the stock if you’re bearish and expect it to fall. 

With options, you can also bet on the rise or decline of volatility — i.e., how much the share price will move. Yet options have time constraints. At the expiration date, the option’s price hits zero.

The options pricing formula is quite complex. (It won the Nobel Prize in economics.) But you should know that the more volatile the stock is, the more valuable and expensive its options contracts will be. This is because if the price moves a lot, there is a bigger chance that it would hit the strike price. 

Also, the more time you have until the expiration date, the more valuable and expensive the option would be. This is due to “time value” — that’s the money on top of the profit you would get if you exercised the option right away. The time value is higher for options that have longer expiration dates. So the longer you have until the expiration date, the more chances you have for the price to move even further in your direction, giving you a greater profit. 

Knowing this, we can take a look at some options trading strategies

  • Long call: This is when you buy a call option betting that the stock price will rise above the strike price.  
  • Long put: This is why you buy a put option betting that the stock price will fall below the strike price.
  • Long straddle: If you expect a big move in either direction, you can simultaneously buy a call and a put option with the same strike prices and expiration dates, profiting from rising volatility.
  • Short straddle: If you expect the price to stay the same until a certain date, you can simultaneously sell a call and a put with an expiration on that date, profiting from little or no volatility.

How to Buy Options in 6 Steps 

If you’ve read this far and already know the key options terms and the basic options strategies, you are probably ready to place a trade. Here is a step-by-step guide on how to buy your first options contract.

1. Complete Qualifications at Your Brokerage 

Options are more complicated than stocks. With stock trading, it would likely take some phenomenally bad luck to drive an account balance to zero, especially in the bullish stock market of the last decade. But nearly half of all options expire worthless, and their holders lose 100% of the premiums they’ve paid.

For that reason, brokerages try to make sure that their clients know what the risks are.

To enable options trading, you typically need to complete an application. Your broker will ask questions about your financial situation and investment experience. 

This isn’t an exam, and most brokers are happy to onboard new options traders, which is one of the reasons why single-stock options trading volumes are at record highs. Most of the time, the application is just a formality, and it will be accepted right away or within a few business days.

2. Add Money to Your Options Trading Account 

Some brokers will keep your stock and options accounts separate. If that’s the case, you will need to fund your options trading account by either moving some money from your main brokerage account or wiring money from your bank. 

3. Select the Stock

Now that you’ve got options trading enabled and have funded your account, you’re finally ready to trade. The next step is to select the underlying stock or ETF you want to buy an option for.

4. Choose the Type of Option 

Once you’ve selected the underlying security, you’ll see the table or list of available options. 

Each brokerage and trading platform will present this information differently, yet most will clearly separate call and put options. 

5. Pick the Expiration and Strike Price 

For each type of options contract, there is a long list of available strike prices and expiration dates. 

This data is usually presented as an options chain or options matrix. It’s a table that shows all the listed options for a single security, arranged by expiration dates and strike prices. 

For each contract, you’ll see the bid (the price at which you can sell) and the ask (the price at which you can buy). 

6. Place an Order 

Once you’ve decided which option to buy, you need to file an order. 

Like with stock trading, the main two order types are: 

  • Market: An order to buy or sell immediately at the next available price;
  • Limit: An order to buy or sell at a specified price or better 

Some brokers only offer limit orders for options because stock options prices move too fast and the spread between the bid and the ask is too wide. 

Even if your broker offers market orders for options, it’s usually still better to place a limit order, specifying the price you’re willing to pay. Your order might not get filled, but at least you won’t overpay.

Join the Ranks of Options Traders

old man looking outside the building

As you have seen, it’s not that hard to buy options. Of course, making consistent profits with options trading is a lot harder than just placing your first order. Still, this could be a worthy endeavor that could put you on an accelerated path toward your financial goals. 

Brand new income video from Tim Plaehn (released July 2021)

Video of Tim Plaehn. Click to Play

I’ve just released a new video about a special Challenge not seen in months. If you’re wondering how to collect instant income at will, this video will show you how to do it in 5 days. This may be the most important video for 2021. Here’s the link to the short 15-minute video.