The 2020 pandemic hit many companies hard, while other companies took it as a chance to grow, seemingly unaffected by the state of the world around them. NVIDIA (NASDAQ:NVDA) came out as one of those thriving businesses and achieved gains of 122% in 2020. The company’s graphics processing units (GPUs) were present and needed for trends that accelerated exponentially due to the pandemic, boost...
Stock options are investment opportunities that allow you to either buy or sell a stock at a given price within a predetermined time frame without actually obligating you to carry out the transaction in the end. As its name states, what it is allowing for is the option.
Sounds complicated. So how does this work?
Because the nature of stock options is exponentially different from other investment opportunities, it has its own set of concepts and terminologies. Since you’ll often hear a lot of them any time you’re dealing with stock options in general, we’ll explain the most crucial ones before delving into the question:
- Call option: The options that give you the right to buy at a given price in the future.
- Put option: The options that give you the right to sell at a given price in the future.
- Premium: The value of each option.
- Strike Price: The price at which each option is allowing you to buy or sell a stock.
- Expiration Date: The date at which the option expires.
- Contract: Trading lots, consisting of 100 options.
Now, the question. Let’s imagine that there’s this company that is currently selling their stocks at $50 each, yet your research shows that said company has a growth potential that could very soon elevate their stock values to $70 instead. Usually, you would straight up buy some of their stocks and wait for their value to grow, only now as their owner.
On the other hand, stock options give you another way to carry out that investment. Let’s say that the same company is offering call options with a strike price of $50 and a premium of $5, with a time frame of 6 months before it expires. Because each contract consists of 100 options, the actual cost would end up being $500. However, by purchasing these options, you have the right to buy 100 stocks for $50 each at any moment of your choosing over the next six months.
If your predictions about the company were accurate and their shares were to rise to $70 before the expiration date, your profit would be $1,500 after a $500 investment.
Keep in mind that this scenario is a representation of an ideal one. In reality, not all options trades work out as intended.
If your company’s growth were to be lower than expected, you would end up losing money. It is for that reason that stocks option are considered highly speculative. Nevertheless, your potential losses will always be capped at the premium paid for each option, which some would see as a benefit.
On the other hand, regarding a put option transaction, it works in the same way. The only difference would be that you, as the seller, should look to put your options in the market anytime you expect your company’s stock value to decrease. Likewise, if your company’s losses were to be lower than expected, you are also at a risk of facing losses yourself but are also capping them as a safeguard.
Regarding option broker options
Options traders are typically stricter than other types of brokers regarding their requirements to register to their firms. If you feel comfortable and ready to start trading with options, we highly recommend doing so. However, some features tend to be considered “make or break” among users, so we recommend as well for you to consider the following:
- Commissions and fees: In recent years, commissions have noticeably lowered or have even gone full-on free. You should still give it a good look and make sure the profits don’t go mostly to your brokerage firm due to any unexpected expenses, as it can be a little more common with options brokers than with regular brokers. Also, keep in mind that brokers most commonly charge $0.65 per contract. You might as well use that value for reference when comparing several options.
- Platform: At least when it comes to the most popular options trading providers, it seems to be a trend for their platforms to be full-featured yet complex. A beginner investor might find himself struggling to get through it. Of course, there are more user-friendly alternatives, but it seems common among the market’s biggest providers.
- Resources: Many providers also manage to offer educational resources, which can help any investor interested in doing research regarding his future investments. Some of that information might also be of extreme value for you to get a better hold on options trading. Try and look for a broker that offers just that, as options tend to be highly complex, and it is very easy for them to represent losses.
You should know that there is no such thing perfect options broker in the market, but there are indeed some excellent ones that we can’t help but recommend to you. You might as well give them a look and see if you feel they’re the right fit for you:
- TD Ameritrade
- Ally Invest