Skip to main content
Advertiser Disclosure
We do receive compensation from some partners whose offers appear on this page. We have not reviewed all available products or offers. Compensation may impact the order in which offers appear on page, but our editorial opinions and ratings are not influenced by compensation.

The Ascent Logo The Ascent Logo - Blue circle with an A in it and the ascent a motley fool company to the right of that

  • Credit Cards
  • Banking
  • Brokerages
  • Loans
  • Mortgages
  • Knowledge
  • Latest Picks
  • Search Icon Click here to search

Credit Cards

Top Picks
  • Best of January 2021
  • Cash Back
  • Balance Transfer
  • Travel
  • 0% APR
  • Rewards
  • Bad Credit
Knowledge
  • Beginners Guide to Credit Cards
  • How to Rebuild Your Credit
  • Maximize Your Credit Card Rewards
  • Learn More About Credit Cards
Credit Card Tools
  • Compare Cards
Looking for a new credit card?

Explore the best credit cards in every category as of January 2021.

Get started!

Banking

Top Picks
  • Best Savings Accounts
  • Best Bank Accounts
  • Best Money Market Accounts
  • Best CDs
  • Best Checking Account Bonuses
Knowledge
  • Beginners Guide to Banking
  • Everything You Need to Know About Savings
  • Money Market Accounts Made Easy
  • Learn More About Banking
Looking for a place to park your cash?

Check out our top picks of the best online savings accounts for January 2021.

Get Started!

Brokerages

Top Picks
  • Best Brokers of January 2021
  • Best Online Brokers for Beginners
  • Best Options Brokers
  • Best IRA Accounts
  • Best Roth IRA Accounts
  • Best Robo Advisors
Knowledge
  • How to Open a Brokerage Account
  • Beginner's Guide to Brokerages
  • Learn More About Brokerage
Just getting started?

Explore our picks of the best brokerage accounts for beginners for January 2021.

Get Started!

Loans

Top Picks
  • Best Loans of January 2021
  • Best Personal Loans for Bad Credit
  • Best Loans for Debt Consolidation
  • Best Low-Interest Personal Loans
  • Best Personal Loans for Good Credit
  • Best Personal Loans for Fair Credit
Knowledge
  • Personal Loans Made Easy
  • Debt Consolidation Guide
  • How to Pay Off Debt
  • Learn More About Loans
Thinking about taking out a loan?

Before you apply for a personal loan, here's what you need to know.

Get Started!

Mortgages

Top Picks
  • Best Mortgage Lenders of January 2021
  • Best Mortgage Lenders for Poor Credit
  • Best Refinance Lenders
  • Best VA Mortgage Lenders
Knowledge
  • First Time Homebuyers Guide
  • Home Loans Made Easy
  • The Complete Guide to Refinancing
  • How to Get a Mortgage with Bad Credit
  • Learn More About Mortgages
Tools & Calculators
  • Mortgage Calculator
Compare Rates
  • Today's Mortgage Rates
  • Refinance Rates
  • 15-Year Mortgage Rates
  • 20-Year Mortgage Rates
  • 30-Year Mortgage Rates
  • Jumbo Mortgage Rates
  • VA Loan Rates
  • 5/1 ARM Rates
  • 7/1 ARM Rates
  • FHA Mortgage Rates

Knowledge

Knowledge Section
  • All Articles
  • Credit Card Articles
  • Banking Articles
  • Brokerage Articles
  • Personal Loan Articles
  • Mortgage Articles
  • Personal Finance Articles
Recent Articles
  • Biden Executive Order Aims to Expedite Stimulus Payments for 8 Million Recipients

    Personal Finance

    Biden Executive Order Aims to Expedite Stimulus Payments for 8 Million Recipients
  • Lawmakers Are Already Pushing Back on Biden's $1.9 Trillion Relief Plan

    Personal Finance

    Lawmakers Are Already Pushing Back on Biden's $1.9 Trillion Relief Plan
  • 1 Overlooked Reason Why You May Regret Cosigning a Loan

    Loans

    1 Overlooked Reason Why You May Regret Cosigning a Loan
  • 3 Reasons You May Be Denied a Bank Account

    Banks

    3 Reasons You May Be Denied a Bank Account
  • The Ascent
  • Best Online Stock Brokers
  • What Is Options Trading?

What Is Options Trading?

by: Matt Frankel, CFP  |  Oct. 29, 2020

The Ascent is reader-supported: we may earn a commission from offers on this page. It’s how we make money. But our editorial integrity ensures our experts’ opinions aren’t influenced by compensation.

Options trading is a lot different from trading stocks or mutual funds, but it can come with some real advantages for investors. But what is options trading? In this article, we'll take a look at what options trading is and how it might fit into your investment strategy.

The basics of options

To trade options, you first have to know what they are. An option -- also known as a stock option or equity option -- is a contract between a buyer and a seller relating to a particular stock or other investment. The buyer of the option has the right to force the seller of the option to do whatever the contract specifies within the period of time set by the option. Once the buyer exercises the option, the seller must follow the instructions set by the option.

For example, a call option on a stock gives the option buyer the right to buy a set number of shares at a predetermined price at any time before a specified expiration date. The option seller must sell the stock to the option buyer if the buyer exercises the option.

The most important aspect of an option is that as its name suggests, the buyer of the option has the right to exercise the contract, but is under no obligation to do so. Therefore, the option buyer will only exercise the option when it's smart to do so. In the example above, say that the call option let the option holder pay $100 per share for a given stock (known as the strike price or exercise price). If the underlying stock traded in the market for $50 per share, the option buyer would never exercise the option, because it would be silly to pay $100 for shares the buyer could purchase for $50 on the open market. However, if the share price in the market were $175, then the buyer would exercise the option contract, since $100 would be a bargain compared to the prevailing share price.

There are many different ways to trade options. In addition to call options as described above, put options give the option buyer the right to sell stock at a given price, protecting the option buyer from losses in a stock position or profiting from a stock moving down. You can also combine various call and put options to use more sophisticated options strategies that will turn a profit under a variety of situations. You can also choose to become an option writer and sell options instead of simply buying them.

What are the benefits of options trading?

There are many reasons why options trading can be a great complement to your existing investing strategy. They include the following:

  • Options give you leverage in your investing. An options contract can give an investor cheaper exposure to a stock than buying shares outright, magnifying both profits and losses if the stock price moves.
  • Options can also reduce risk in your overall portfolio. For instance, you can use an option strategy that combines buying a put option to sell stock at a specified price with ownership of the shares themselves. That trade, known as a protective put, gives you the upside if the stock price rises but protects you from a portion of the losses if the stock price falls.
  • Options can offer a source of income. By selling options rather than buying them, you're the one to receive the payment for the option. Even if the option goes unexercised, you get to keep that payment as compensation for having assumed the obligation for the contract.

What are the risks of options trading?

Offsetting these benefits are some real risks to options. First and foremost, options often expire worthless, resulting in a total loss of whatever the buyer paid for the option. For those used to seeing stock moves of even 5% to 10% as a really big deal, the volatility of options can come as a huge shock.

Second, there's a learning curve involved with options trading. Many brokerage companies offer options trading, but you'll have to meet some added regulatory requirements before your broker will let you actually use options as part of your trading strategy. For instance, you'll have to read some educational material about the options market as well as learn how your broker handles accepting orders for options. In addition, you'll need to know what you have to do to tell your broker that you want to exercise an option -- as well as what'll happen if you sell an option and the buyer decides to exercise it against you.

Finally, there are some options strategies that only work well when you make multiple trades simultaneously. Because options markets aren't always as liquid as the stock market, those simultaneous trades don't always work perfectly -- and that can introduce the risk that your strategy won't work the way you intended or hoped.

Picking the best options broker

If you want to trade options, then finding a top stock broker is crucial. Here's what to look for:

  • Low commissions: Virtually all online brokers have eliminated commissions on stock trades. But the same typically isn't true with options -- a few brokers offer free options trades, but the majority charge a modest per-contract position for options.
  • Good research: Special tools for evaluating options can be very useful, but not all brokerage companies offer them.
  • Good trading platform: Any no-frills trading platform can be fine for buy-and-hold stock investors, but a feature-packed platform can be a major advantage for an options trader.
  • Great customer support: Options traders are more likely to have to talk to customer service agents in order to get their trades done the way they want, especially for more complicated strategies. Nothing's more frustrating than having a broker's customer service representatives not really understand what you're trying to do with your options trading.

Take a closer look at options

Of course, options trading is a far more complex subject than we can explain in a 1,000-word article, so it's important to spend some time learning about various options strategies and the risks involved before you get started.

Options trading takes more effort to do well than stock trading, and options can downright scare some investors. But by understanding the pros and cons involved with trading options, you'll be able to decide whether options are right for you -- and then find a broker that'll help you get the job done.

About the Author

Matt Frankel, CFP
Matt Frankel, CFP icon-button-linkedin-2x icon-button-twitter-2x

Matt is a Certified Financial Planner® and investment advisor based in Columbia, South Carolina. He writes personal finance and investment advice for The Ascent and its parent company The Motley Fool, with more than 4,500 published articles and a 2017 SABEW Best in Business award. Matt writes a weekly investment column ("Ask a Fool") that is syndicated in USA Today, and his work has been regularly featured on CNBC, Fox Business, MSN Money, and many other major outlets. He’s a graduate of the University of South Carolina and Nova Southeastern University, and holds a graduate certificate in financial planning from Florida State University.

Like this page? Share it!

Blue Facebook Icon Share this website with Facebook
Blue Twitter Icon Share this website with Twitter
Blue LinkedIn Icon Share this website with LinkedIn
Blue Mail Icon Share this website by email

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.

The Ascent Logo

The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters.

btn_facebook-yellow btn_twitter-yellow btn_instagram-yellow

Copyright © 2018 - 2021 The Ascent. All rights reserved.

About The Ascent
About Us Contact Us Newsroom How We Make Money Editorial Integrity Ratings Methodology
Legal
Terms of Use Privacy Policy Accessibility Policy Terms and Conditions Copyright, Trademark and Patent Information
Learn
Credit Cards Banking Brokerage Loans Recent Articles

By submitting your email address, you consent to us sending you money tips along with products and services that we think might interest you. You can unsubscribe at any time. Please read our Privacy Statement and Terms & Conditions.

Back to The Motley Fool