Stock market options are limited term contracts which give investors the right to buy or sell individual stocks at a preset price. The two types of options -- puts and calls -- can be used in a wide range of trading strategies to profit from expected stock price changes. You must first apply for account authorization to start buying and selling puts and calls.
Options Trading Account
An options trading account is a cash, margin or IRA stock brokerage account to which options trading authorization has been added. You add options authorization by completing a separate application, including a disclosure of your trading experience. The broker's compliance department reviews the options application and approves your account with a trading authorization level ranging from one to five. The authorization levels determine which options strategies can be traded in the account. Novice investors will receive level one or two authorization, which allow lower-risk options strategies.
Buying and Selling Options
Option contracts are bought and sold using the options trading screen of your online brokerage account. Different put and call option choices can be found under the options-chain link of a particular stock. Selecting an option from the chain populates the trading screen with the details of a particular option. You can then enter how many contracts you want to buy or sell and set a limit price if desired. The currently quoted "ask" price of an option is what you will pay to buy with a market order. The "bid" price is what you will receive if you sell at the market. Each option contract is for 100 shares of the underling stock, so one contract costs 100 times the quoted price.
Open and Close Orders
Options can be either purchased or sold to initiate a trading position. Buying options gvies you the right to buy (call options) or sell (put options) shares of the underlying stock at a specific price. Selling options adds option premium income to your account and the obligation to deliver or buy shares if the buyer exercises his rights under the options you have sold. To open an options position you enter a buy-to-open or sell-to-open order, depending on your strategy. To close out an options position in your account, the order will be a sell-to-close or buy-to-close.
The large number of puts and calls with different parameters trading against each stock allows an options trader to combine different contracts into a single trading strategy. This strategy can include both buy- and sell-to-open orders to achieve the desired profit and risk potential. There are about 40 developed strategies for trading options. Many online brokerage accounts let you select the specific options. as well as a strategy to have all of the required inputs populated to an options trading screen. You then initiated or close the strategy with a single order.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.