Five tips to level up your options analysis
When it comes to options trading, there’s more to it than just buying puts and calls. Options are risky and for many investors, they can be wary of trading them—for good reasons. Options are complex; the potential to lose money can be high; and they can be tricky to grasp.
But when you’ve defined your investment goals, financial limitations, and options knowledge, this can help put you on a potential path to not only begin options trading but also enhance it if you’re already started.
Read on to learn five options trading tips to potentially aid you in your journey.
What are options?
Options give the owner the right, but not the obligation, to buy or sell an underlying asset at a certain price (the strike price) for a specific period of time (until expiration or expiration date). The contract also obligates the writer (the seller) to meet the terms of delivery if the owner (buyer) exercises the contract right.
Investors can use options for risk management through hedging. There are many different options strategies, varying in complexity from beginner ones like long calls to more advanced, such as long strangles. Investors may discover opportunities to achieve potential profits through options trading, but considering and understanding the risks associated with trading them is important.
Whether you’re new to options trading or have been active for a while, we’ve put together five tips to consider when trading options. Let’s get started.
Review your trading habits before considering opening an options trading account
Regardless of any investment product you choose, before you get started, it’s important to define your investment and trading habits, your values, and your goals. One way to accomplish this is by creating a trading plan; however, for options trading, you’re required to revisit some of this information before you’re allowed to trade options, per FINRA rules(1).
To open an options trading account, you’ll need to first share some specific personal background information and investment experience. This must be approved by the brokerage or online trading platform before you can open an options account and begin trading.
This background information includes the following(2):
What are your investment objectives? This typically includes growth, income, capital preservation, or speculation.
What is your trading experience? This can encompass the length of time you’ve been trading stocks and/or options, your investing knowledge, the number of trades made annually, and the average trade size.
What is your income and other personal background? Questions include annual income, total net worth, liquid net worth, and employment information.
What types of options do you want to trade? This can include puts, calls, or spreads. Will these be naked or covered?
Based on your answers, you will be assigned by the broker or trading platform with a trading level, typically between 1 to 5, based on your risk and experience evel. A ranking of 1 signifies the lowest risk and 5 represents the highest.
If approved with a ranking, you can begin making options trades.
Tip one: Look to invest in options products that match your experience and investment goals
After defining your investment background, objectives, and the types of options you want to trade to open your options account, the next step is to determine what type of options product you want to trade, such as equity options or index options.
Equity options (stock or ETF options) give the owner the right, but not the obligation, to buy or sell an underlying stock at a certain price (the strike price) for a specific period of time (either on or before the expiration date) at a price (premium). The contract also obligates the writer (the seller) to meet the terms of delivery if the owner (buyer) chooses to exercise the contract right.
An index option gives the owner the right (but not the obligation) to buy or sell the value of an underlying financial benchmark, such as the S&P 500® index (SPX) or the Cboe Volatility Index® (VIX), at a listed exercise price. Actual underlying stocks are not bought or sold.
Besides the underlying security, equity options and index options differ in additional respects. This includes settlement, exercising, volatility, and depth of options to choose from to trade. Understanding their differences and the potential complexities can help you make a choice that’s right for you.
Tip two: Double check that your brokerage offers competitive fees.
Many investors will set aside funds for trading but factoring in brokerage fees may sometimes be forgotten, like fees on hotel rooms and concert tickets. Brokerage fees are charges for different services, such as trade executions or premium services like research. They’re typically based on a percentage of the transaction, a flat fee, or a combination of the two; they are charged by discount, full-service, and online brokers.
[To learn more about fees, read, Brokerage Fees 101: Everything You Need to Know About Trading Fees]
Today, many online trading platforms and brokerage firms can offer investors either no-fee or low trading fees. It’s important to compare and understand different fee options to keep your trading costs as low as possible. Review your firm’s fee schedule for detailed information around different costs that may be charged to you and remember to ask for guidance when needed.
Before your trading fees start to add up, here’s a few things you may want to consider.
Low fees: Online brokers typically have the least expensive brokerage fees because investors conduct their trading online with limited offerings for customer services. For options trading, there can be an industry norm contract fee(3), typically between $$.65 to$$1.00.
But in today’s competitive online trading environment, investors may find lower fees, including zero commission fees. Doing a little research can go a long, less expensive way.
Cash sweep program: Participating in a cash sweep program won’t rid you of paying fees but it can help you set aside some funds if you are planning to trade and invest. This program allows your cash balances to grow over time.
It works like this. You can deposit money into your investment account that’s intended to purchase securities, but you don’t plan to use funds in the short term. The brokerage will automatically transfer uninvested cash amounts into a deposit account at a program bank that earns interest.
When you are ready to trade, funds can be pulled from a cash sweep program for you to make it without needing to either make a deposit or transfer money to do so, assuming it covers the cost of the transaction. A cash sweep program also provides an opportunity to earn interest on any uninvested cash.Note: Be sure to do your research about your broker’s cash sweep program, including how FDIC coverage works for swept cash at program banks, and what other alternatives there are to earn interest for your idle cash.
Tip three: Build your options analysis toolbox
It’s one thing to place trades to buy or sell options, but using different options analysis tools can help you go further in your options trading journey: they can assist you in understanding the current market, employ options strategies, and conduct options analysis.
Many online trading platforms will offer these for free. Here’s a few tools to get you started.
Pre-set options strategies: Pre-set strategies enable you to potentially save time when building the strategy, offer greater functionality, and easier order entry—all from a few clicks. These strategies, for investors of varying experience levels, can include call/put, covered call/put, collar, straddle, strangle, butterfly, vertical, condor, iron butterfly, and iron condor strategies. You can also create custom strategies by choosing 2-4 options with different expiration dates to form an additional multi-leg options strategy.
Real-time options chain: Options prices fluctuate so having a timely understanding of the current marketplace is helpful for quick order transactions and market opportunities. Investors can glean this information through a real-time options chain, which is updated typically from milliseconds to a few seconds.
An options chain lists all available option contracts, puts and calls, for a specific underlying security. Typically organized by expiration date, it also shows pricing information, such as last prices, trading volumes, best bid and offers, and strike prices for the specific underlying stock within a stated expiration date.
Powerful options analysis tools: Maybe you want to get even more granular with your options research.
Additional tools for your options toolbox may include reviewing profit and loss (P/L) analysis, which can give you a theoretical picture of your option’s potential performance at expiration before entering a new position. Unusual options activity shows real-time insights into high-volume options transactions as well block buys and sales from institutions for specific options contracts. And for traders interested in 0DTE options, there’s also listings for top options by volume.
Note: 0DTE options are not suitable for all investors and should be utilized only for sophisticated investors who understand the essentials of options and the risks of 0DTE options.
Tip four: Leverage Level 2 data
Some say data is king and the same can be said for Level 2 market data.
This market data, also referred to as an order book, shows a list of orders placed for a specific option to buy or sell over time, providing deeper insights into the bid and ask scope submitted by options exchanges. These quotes are in real-time, showing the order book’s depth through order volumes, last sales, and sometimes market participants.
Online brokers may provide this and investors with approved options accounts can utilize this data. This can help them review options they are interested in trading and see the current market for open trades, helping them make potential trades.
Tip five: Practice your strategies before putting them to work
Trading options isn’t easy so practicing before you go live is one way to get started.
Think paper trading.
Paper trading is simulated trading that allows you to practice buying and selling options in a realistic market environment using real-time quotes and data. Beginning options traders can also get comfortable using an online broker’s platform while more advanced traders may want to try different options strategies, risk free.
You don’t need to put real money down to use paper trading, but you will need to put in the time. By doing so, you will be able to gain experience, self-discipline, and confidence.
And if paper trading sounds too overwhelming, consider taking some time for options education.
There are many online webinars, educational content, and communities that can help you get started, and answer your questions. All this can also come at no cost and pay off in the long run.
It is important to understand options trading can bring trade-offs, risks, and rewards.
One way to start is through building an options analysis toolbox. This can provide a way to gain a greater understanding of options trading over time and help you become a well-informed options trader for the long term.
Sources:
1. Investor Bulletin: Open an Options Account
2. FINRA Reminds Members About Options Account Approval, Supervision and Margin Requirements
3. Trading Fees: What Do Brokers Charge to Trade?
Options trading entails significant risk and is not appropriate for all customers. It is important that investors read Characteristics and Risks of Standardized Options (https://j.us.moomoo.com/00xBBz) before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount. Supporting documentation for any claims, if applicable, will be furnished upon request. Moomoo does not guarantee favorable investment outcomes. The past performance of a security or financial product does not guarantee future results or returns. Customers should consider their investment objectives and risks carefully before investing in options. Because of the importance of tax considerations to all options transactions, the customer considering options should consult their tax advisor as to how taxes affect the outcome of each options strategy.
There is no guarantee or assurance that the use of any tools or data provided on the moomoo app will result in investment success or reduce investment risk. Past performance does not guarantee future results.This article is for educational use only and is not a recommendation of any particular investment strategy. Content is general in nature, strictly for educational purposes, and may not be appropriate for all investors. It is provided without respect to individual investors’ financial sophistication, financial situation, investment objectives, investing time horizon, or risk tolerance. You should consider the appropriateness of this information having regard to your relevant personal circumstances before making any investment decisions. All investing involves risks.