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What Is Options Trading? Learn the Basics

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Written by Timothy Sykes
Updated 4/20/2023 9 min read

The basics of options trading is the buying and selling options contracts, which give you the right to trade a stock at a specific price. It’s a major trading niche popular with many people. Even if you don’t trade options, it’s still a good idea to learn about them.

I don’t trade options, but my former student — and current Trading Challenge mentor — Mark Croock does. He’s evolved my penny stock trading style to work with options trading, and made $3.9 million in the process.

There’s a steep learning curve for options trading even if you understand stock trading. But that’s what I’m here for — read on to learn more about options trading and see if it’s right for you!

How Does Options Trading Work?

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Options trading works through speculation. When trading options, you predict an asset’s price movements in a specific time frame. If your plan is right, you can make a profit.

Options contracts have no value in themselves—they’re derived from actual stocks and assets. These contracts give you the right to trade a stock at a certain price on or before its expiration date. They’re like stocks in that you can access them through online brokers and trading platforms.

Do you want to trade options on Robinhood? Check our guide on how to do it.

The two parties in the options market are the holder/option trader and the writer/option seller. The holder pays the writer for the option contract. This gives them the right to trade a stock at a certain share price within a specified period of time.

The money you pay the writer is called a “premium”. If you let your contract expire without trading, you’ll only lose the premium. The price specified in the options contract when it kicks in is called a “strike price”.

Learn more about how options trading works in this guide.

Why Invest Time Into Trading Options?

Time is your most valuable resource. If you’re trading options, you better be prepared to put the time in.

Here’s a quick breakdown of the advantages and disadvantages of option trading:

Advantages of Trading Options

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  • Options are flexible — you don’t have to buy the asset in question if you don’t think you’ll profit. You’ll only lose the option premium and nothing else if you let the contract expire. Or you can sell the option itself before the expiration date.
  • Options are available for numerous investment vehicles, not just stocks. You can also buy options for indices, commodities, foreign currencies, and more.
  • Options reward good speculation. Forget my advice about not predicting the market. A certain amount of prediction is necessary for options trading — even though it’s all in the chart.

Disadvantages of Trading Options

  • Options trading has a bigger learning curve than traditional stock trading. There’s a new set of jargon and rules to learn, which might turn off newer traders.
  • Brokerages limit stock options trading by default. You need to get approved by fulfilling certain requirements before trading options.
  • Certain options trading strategies have a substantial risk of unlimited losses. Stay the heck away from naked options!

Different Types of Options Contracts You Can Trade

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There are two basic types of options you can trade. Here’s a breakdown of each type of options contract:

Call Options

Buying a call option means you’re getting the right to purchase a stock at the specified strike price. Here’s an example of a call option in action:

Let’s say you expect a $40 stock in Company X will rise by 10% within the next few months. You can buy a call option to purchase 200 shares at $44 per share.

This is an “out of the money” (OTM) option. OTM options are less expensive than “in the money” (ITM) options, because they can’t be exercised until their strike price is attained.

Suppose Company X’s stock hits $46 before your option contract expires. If that happens, you can buy 200 shares at the $44 strike price and profit from the difference. But if the stock price never exceeds $44, you can ignore the option and lose your premium.

Put Options

A put option is essentially the opposite of a call option. It gives you the right to sell stock at a predetermined strike price. Here’s an example of it in action:

For instance, you project that Company X stock will fall from its current price of $40 in the near future. You get a put option to sell 200 shares of Company X stock two months from now, at a strike price of $36.

This is basically the shorting version of the call option example above… That’s one of the reasons that Robinhood traders use options so much — Robinhood doesn’t allow them to short!

Put options are a little harder to use, though. Level 1 covered calls require ownership of the underlying security when the contract executes.

If you already have shares in the underlying asset, you can use your shares to exercise the option. If stock prices go up, you can just sell your shares like normal. Traders call this option strategy “hedging.”

What happens if you don’t own the underlying security? You can sell the contract itself!

How to Trade Options

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Stock trading and options trading are different financial products. But my basic trading approach still works here:

  • Study charts.
  • Learn options strategies from successful traders.
  • Make your own watchlists and plan your own trades.
  • Don’t copy other people’s picks.
  • Track your trades.

Options trading is a marathon, not a sprint. Wins and losses matter, but they’re not everything. What’s important is improving your trading technique every single day.

Options trading simulators can help you hone your strategy. But don’t spend too long on this step — paper trading won’t teach you about emotional control when real money is on the line.

The best way to build your knowledge account is by learning from experienced traders and options professionals. Find a mentor who shows both their wins AND losses, like my former student Mark Croock.

Mark is one of the most disciplined traders I know. When he adopted my Trading Challenge strategies to options, I got excited…

I know Mark’s teaching approach well. Now that he’s tailoring his strategies for options trading at Evolved Trader, I’ve found a course I can wholeheartedly recommend.

Check out Evolved Trader here!

Trading Options Scenarios

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Mark’s Evolved Trader alerts trades are full of teachable options trading scenarios. Here’s one that I like A LOT.

Mark had been tracking Marathon Digital Holdings Inc. (NASDAQ: MARA) through its January ramp up. The stock had gained 175% from the end of December to mid-January, and looked like it was losing steam…

First he tried buying puts with an $8.50 strike price as it was showing signs of fading on January 17. It didn’t break down, and he cut his losses quickly.

The next day, his timing was perfect. He set the strike price at $8. MARA fell below $7.

His gains on the trade came to $26,533 (starting stake $63,867).

At the same time, he had a call working with a $6 strike. He sold it when MARA bounced back up on January 20 for a gain of $107,283 (starting stake $59,815).

Mark didn’t just get lucky. He’s been tracking the crypto sector for a long time. Here’s one of his masterpieces from 2022:

American vs European Options

European and American options aren’t sold on different stock markets. They’re two different types of option contracts.

Here’s the key difference between these two options types:

European options can only be exercised on the expiration date. Meanwhile, American options can be exercised for the entire time period up to and including expiration. American-style options are more flexible, so they’re more valuable.

Both options types are available on U.S.-traded stocks. But you can’t choose which one you get when buying an options contract.

Most stocks and exchange-traded funds use American-style options. In contrast, many index-based options use the European style.

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Timothy Sykes

Tim Sykes is a penny stock trader and teacher who became a self-made millionaire by the age of 22 by trading $12,415 of bar mitzvah money. After becoming disenchanted with the hedge fund world, he established the Tim Sykes Trading Challenge to teach aspiring traders how to follow his trading strategies. He’s been featured in a variety of media outlets including CNN, Larry King, Steve Harvey, Forbes, Men’s Journal, and more. He’s also an active philanthropist and environmental activist, a co-founder of Karmagawa, and has donated millions of dollars to charity. Read More

* Results are not typical and will vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk. See Terms of Service here

The available research on day trading suggests that most active traders lose money. Fees and overtrading are major contributors to these losses.

A 2000 study called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” evaluated 66,465 U.S. households that held stocks from 1991 to 1996. The households that traded most averaged an 11.4% annual return during a period where the overall market gained 17.9%. These lower returns were attributed to overconfidence.

A 2014 paper (revised 2019) titled “Learning Fast or Slow?” analyzed the complete transaction history of the Taiwan Stock Exchange between 1992 and 2006. It looked at the ongoing performance of day traders in this sample, and found that 97% of day traders can expect to lose money from trading, and more than 90% of all day trading volume can be traced to investors who predictably lose money. Additionally, it tied the behavior of gamblers and drivers who get more speeding tickets to overtrading, and cited studies showing that legalized gambling has an inverse effect on trading volume.

A 2019 research study (revised 2020) called “Day Trading for a Living?” observed 19,646 Brazilian futures contract traders who started day trading from 2013 to 2015, and recorded two years of their trading activity. The study authors found that 97% of traders with more than 300 days actively trading lost money, and only 1.1% earned more than the Brazilian minimum wage ($16 USD per day). They hypothesized that the greater returns shown in previous studies did not differentiate between frequent day traders and those who traded rarely, and that more frequent trading activity decreases the chance of profitability.

These studies show the wide variance of the available data on day trading profitability. One thing that seems clear from the research is that most day traders lose money .

Millionaire Media 66 W Flagler St. Ste. 900 Miami, FL 33130 United States (888) 878-3621 This is for information purposes only as Millionaire Media LLC nor Timothy Sykes is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Millionaire Media LLC and Timothy Sykes cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Millionaire Media LLC and Timothy Sykes in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Millionaire Media LLC and Timothy Sykes accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

Citations for Disclaimer

Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: “Day Trading for a Living?”

Barber, Brad M. and Lee, Yi-Tsung and Liu, Yu-Jane and Odean, Terrance and Zhang, Ke, Learning Fast or Slow? (May 28, 2019). Forthcoming: Review of Asset Pricing Studies, Available at SSRN: “https://ssrn.com/abstract=2535636”

Chague, Fernando and De-Losso, Rodrigo and Giovannetti, Bruno, Day Trading for a Living? (June 11, 2020). Available at SSRN: “https://ssrn.com/abstract=3423101”