What are my options? Beginner’s guide to options trading

Options trading (sometimes simply called “options”) might sound like something reserved for high-flying traders, but it’s a strategy that everyday investors can learn to use – if you’re willing to put in the time and patience that is.

If you’re in the UK and curious about options trading, this guide will break it all down for you so that you can decide if this is a strategy you’d like to pursue to level up your trading.

This is a paid content promotion brought to you by Robinhood. Choose a free fractional share in an S&P 500 company when you sign up. Capital at risk. T&Cs apply.

What is options trading?

At its core, it’s a way to trade based on (or hedge against) price movements in stocks or other assets. An option is a contract that gives you the, you guessed it, option to buy or sell an asset at a predetermined price (strike price) within a specified time frame (expiration date).

There are two main types of options:

1. Call options. These contracts give you the right (but not the obligation) to buy an asset at a set price within a specified time period. You’d buy a call option if you think an asset’s price will rise, and you’d sell a call option if you think the price will fall (or expect limited price movement).
2. Put options. These contracts give you the right (but not the obligation) to sell an asset at a set price within a specified time period. You’d buy a put option if you think an asset’s price will fall, and you’d sell a put option if you think it will rise (or stay at current levels).

These options allow traders to potentially profit from rising or falling markets without necessarily owning the underlying asset, though selling options can involve significant risk.

What are options used for?

There are 3 key reasons investors might consider using options:

• Speculating on price. If you think you’ve got a solid theory about whether the price of an asset is going to go up or down, you can buy call and put options (“calls” and “puts”) at a fraction of the actual investment’s price.
• Generating income. By selling options, you can actually earn income from stocks or investments. Using various options trading strategies like “covered calls” or “cash secured puts” can allow you to generate income from the “premium” that’s paid by the buyer of the options.
• Protecting yourself. Options can be a tool to hedge (protect against) market movements, used almost like an insurance policy. For example, using put options is a common hedging strategy because opening a position to sell the assets you’re holding can help limit downside risk.

Why trade options?

Once you know how to use them, options can be a powerful tool for investors. Here’s why some people choose to trade them:

• Flexibility. Options can be used in bullish, bearish, and even sideways markets.
• Leverage. You can control a large number of stocks with a relatively small upfront investment.
• Risk management. Smart use of options can allow you to hedge against potential losses in your portfolio.
• Income generation. Along with dividend investing, some traders use options to generate regular income through strategies like covered calls.

However, options also come with risks, so it’s important to understand them before diving in.

Where can you trade options in the UK?

You can trade options through various UK brokers, but here’s why Robinhood is a standout option (excuse the pun):

• Low fees. You can trade options with a $0.50 contract fee. Other costs apply.
• Trade index options. You can trade options on broad market indices, like the S&P 500, for example*.
• Research tools. Robinhood gives you access to free tools like its “Options Strategy Builder” and “Simulated Returns” calculator.
• Learning resources. To level up your options education, Robinhood’s learning area has guides and videos to help you find your feet.
• Ongoing support. Unlike some platforms, Robinhood has a dedicated support team of options specialists available around the clock, 24/7.

*Options are higher risk products not suitable for all investors, you could lose more than your initial capital. Fees apply.

Understanding key options terms

Before you start trading options, here are some essential terms worth knowing:

• Strike price. Sometimes called “exercise price” (don’t worry, no treadmills were harmed in the making of this guide), it’s the price at which you can buy (for a call) or sell (for a put) the underlying asset.
• Expiration date. The date by which you must exercise your option – think of it like a due date for your baby options. It can be days, weeks, months, or even years down the road.
• Premium. The cost of buying the option, consisting of “intrinsic value” and “time value”. Intrinsic value is based on the difference between an asset’s market price and the option’s strike price. The time value is based on the amount of time before the option expires.
• In the money (ITM). A call option is ITM when the stock price is above the strike price, and a put option is ITM when the asset price is below the strike price.
• Out of the money (OTM). A call option is OTM when the stock price is below the strike price, and a put option is OTM when the asset price is above the strike price.
• At the money (ATM). This is when the asset price is equal to the strike price. Not to be confused with the place where you withdraw cash from your current account.

Common options strategies for beginners

If you’re new to options, it’s best to start with simple strategies. Here are two useful options trading strategies for beginners:

1. Covered call strategy. If you already own shares of a company, you can sell (write) a call option on those shares to generate income if you don’t think the price is going to move much. Holding the shares is your cover, and if the option expires without being exercised, you keep the premium as income.
2. Protective put strategy. You own shares and want protection against a potential drop in price. You buy a put option as insurance to hedge against losses. If the stock price falls, your put option increases in value, offsetting your losses. If the stock price rises, you benefit from holding the shares.
   These strategies can help you get comfortable with options while managing risk.

Risks of options trading

While options trading can offer many benefits and alternative ways to make money, it also comes with risks to consider:

• Losing your investment. If an option expires worthless, you lose the premium you paid.
• Leverage risk. While leverage (borrowing money) can amplify gains, it can also magnify your losses.
• Complexity. Trading options is more complicated than simply buying stocks, so it takes time to learn and practice.
• Assignment risk. If you sell options, you might be forced to buy or sell the underlying asset.
• Liquidity risk. Some options have low trading volume, which can make them harder to exit because there are fewer buyers and sellers.
• Time decay. If an option loses value as expiration approaches, this can impact your profit.

Like with most areas of investing and trading, the key to success is education and practice. Avoid investing more than you can afford to lose if you’re thinking about trading options.

Bottom line

Options trading can be a useful way to diversify your investment strategy, hedge risks, and even generate income. However, it’s important to fully understand the mechanics before jumping in.

By starting small, sticking to simple strategies, and continuously learning, you can navigate the world of options trading with a degree of confidence. Always consider the risks first and don’t invest more than you can afford to lose.

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Written by

George Sweeney, DipFA

Deputy editor

George is a deputy editor at Finder. He has previously written for The Motley Fool UK, Nasdaq, Freetrade, Investing in the Web, MoneyMagpie, Online Mortgage Advisor, Wealth, and Compare Forex Brokers. He's focused on making personal finance and investing engaging for everyone. To do this he draws from previous work and his Level 4 Diploma for Financial Advisers (DipFA), sharing what he’s learnt. When he’s not geeking out about money, you’ll find him playing sports and staying active. See full bio

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