Options Trading – Top 5 Best Online Brokers for Trading Options
|1||OptionsHouse||Options: $8.95 + $0.15/contract|
Lowest Commissions. Fast Execution
|2||Trade Monster||Options: $0.00 + $0.50/contract|
Pay only per contract. $12.50 minimum
|3||OptionsXpress||Options: $14.95 Flat Rate (up to 10 contracts)|
Then $1.50/contract. Excellent platform
|4||TradeKing||Options: $4.95 + $0.65/contract|
Low commissions. Very fast execution
|5||Cobra Trading||Options: $5.00 + $0.95/contract|
Supports multiple trading platforms
What is Options Trading?
Options are a type of derivative financial instrument that creates a contract between two parties relating to the buying or selling of an underlying asset at a specified price at a future date. Unlike futures contracts, options give buyers the right, but not the obligation to buy or sell the underlying asset at the specified price. Like Futures trading, the concept of trading options may sound overly complex, but in reality its a lot simpler than it sounds. In the world of options there are two kinds options; an option which gives buyers the right to buy an underlying asset is is known as a “call” while an option which gives buyers the right to sell is known as a “put”. Options can be bought or sold for most publicly traded stocks, but can also be bought or sold for other assets (Bonds, Currency, Futures Contracts, Etc).
Trading options for stocks is the the easiest and most common form of options trading. Investors who purchase a “Call” option on any stock or asset has the “option” to purchase that particular asset at any time up until the “expiration date” at the “strike price”. If the value of the asset rises above the strike price, the investor profits, as he or she can then purchase that asset at the strike price and sell it at the market price. An investor can profit from an option without ever having to exercise it, as they can simply sell the option on the open market. Put simply, those who purchase Call options for a stock are betting that the price of that stock will appreciate above the “strike price”. Put options on the other hand, are the exact opposite of Call options. Someone who purchases a put option for a stock has the “option” to sell that stock up until the expiration date at the “strike price”. Put simply, someone who purchases a put option for a stock is betting that the price of that stock will decline below the “strike price”. Investors can buy and sell options without ever owning the underlying asset that the option represents.
Writing Options and Exchanges
Options do not appear out of nowhere. Options are “created” when investors “write” options. The originator of the options (the writer) collects a payment, called the premium, from the buyer. The premium for writing an option is based on the forces of supply and demand for options on that particular asset. The person who writes an option must be able to deliver the underlying asset if it’s ever exercised in the future. When an option expires, it can no longer be exercised, and thus becomes worthless. Options trading (buying, selling and writing) commonly takes place on options exchanges, which basically operate in the same way stock exchanges do in connecting buyers and sellers. Like futures contracts, options for stocks are largely “standardized” which means that a single options contract represents 100 shares in an underlying stock. There are specialty contracts out there, so make sure to do your own due diligence before purchasing any security.
Risks of Options Trading
Unlike trading stocks, mutual funds or ETFs, trading options is considered much more risky. Most online brokers require investors to have at least a few years of experience in trading and an understanding of options before even allowing them to begin trading options. Simply activating options trading on any online brokerage requires investors to read, understand and sign a form called “Characteristics & Risks of Standardized Options” which can be found here. The purpose of this form is to let investors know exactly what they’re getting into, as trading options for the most part carries more risk of loss (as well as potential for gain) than simply trading stock.
Options Trading Commissions
Online options trading brokers generate revenues by charging their customers trading fees. Unlike trading stocks and ETFs which usually have flat rate fees, trading options can be much pricier. Online brokers tend to charge a flat rate commission PLUS a “per contract” fee ranging from $0.15 to $1.25 per contract, so depending on which online broker an investor uses, total commissions can vary widely. Comparing online options brokers is the best way to find brokers with the lowest commissions. Some brokers are better for trading options than others. Just because one broker has the lowest commissions on stock trading doesn’t mean they will have the best rate for options trading.
Options Trading Strategies
There are numerous strategies for trading options online. Many online brokers offer resources, tutorials, videos and other educational materials for their clients. Investors are encouraged to take advantage of these resources as well as do some of their own research. There are countless options trading strategies out there, but one of the most popular strategies is a selling a covered call. A Covered Call is a popular strategy that involves an investor selling call options in a stock or security that he or she already owns. Not only will the seller of the option collect a premium on the sold calls, but If the price of the stock rises above the exercise price, the trader who sold the call option would be required to sell their stock at the exercise price, which would guarantee the seller a fixed profit. The downside of a covered call trade is that the seller of the covered call could miss out on much larger gains if the value of the underlying stock shoots up well above the exercise price, in which case not selling any call options would have been much more profitable. If the price of the underlying stock decreases, the sold call option may never be exercised. The strategy is called a “covered” call because the investor selling the call options has enough stock to delivery to the buyer if the option is ever exercised. For more advanced strategies see our Advanced Options Trading Strategies piece.