Have you ever wondered about learning how to Trade Stock Options ?
We offer a practical guide on how to successfully do that despite the odds.
Trade Stock Options: Beginner’s Guide
Regardless of anyone’s background, the internet has made it possible nowadays to gain access to numerous markets across the globe within the comfort of one’s house with a computer and an internet connection.
The best first thing one can do before embarking on this journey is to gain knowledge, more knowledge and further knowledge.
For that, I would suggest these books by those who have walked the very steps you are about to take.
In no particular order even though the first one is a MUST:
- Pit Bull : Lessons from Wall Street’s Champion Day Trader by Martin Schwartz
- Reminiscences of a Stock Operator by Edwin Lefevre
- One Up On Wall Street by Peter Lynch
- The Intelligent Investor by Benjamin Graham
Just in case one might be wondering about the correlation between reading some rather old books and Trading Stock Options in today’s markets.
Yeah, Stock Operator is a 1923 novel.
The Intelligent Investor was first published in 1943.
I have a two-fold answer.
Firstly, perspective is very a valuable thing and secondly, the “game” remains the same.
Only the tools may have changed when it comes to Trading Stock Options.
More to come on this in subsequent Chapters.
How to Trade Stock Options: The Benefits of a Good Foundation
Armed with the concepts from these books, I was able to gain a better understand of the market.
As a result, I can stay focused about the end game and focus on what really matters most.
Consider the time spent on reading part of your warm up.
For those in athletic fields, it is a given that no great performance has ever been achieved without proper warm up.
Pro-athletes we admire can attest of the necessity of this phase of their routines prior to perming at the peak levels they have accustomed us to.
After the reading of the books, we shall next tackle take on setting up online accounts.
Yes plural for the very reasons explored below.
Setting Up Online Accounts
This process comes with finding a good stock trading platform.
Until a week or so ago, price was one of the factor in making this decision.
The good news is that all majors brokers (E*trade, Charles Swab, Fidelity, TD Ameritrade) now have zero commissions on equities and Options trades.
That is music to the ears of all over-traders (I was one!) and all traders in general because commissions could accumulate and could lead to reduction in Net Profit.
Therefore, a good broker is defined by the platform it services its customers and the slight cost to trade options contracts.
But first, I strongly suggest selecting a broker that offers a Paper account.
In the below video, we are comparing two such platforms in this eOption App vs eTrade Review.
Yes, a paper account where one can practice and setup simulated trades in order to validate one’s methodology.
We shall devote a whole section on this concept later.
For now, any broker that can provide a Level 2 Options account (ability to buy and sell Calls and Puts) with a paper account will do the job.
E*TRADE just happens to be the one I signed up with.
Actually, It was called OptionsHouse back then in 2016 and ended up being bought by E*TRADE.
As a bonus, it would be helpful if the broker of your choice provide self-paced free education on trading Stocks Options through self-paced material or through regular webinars.
Once you have access to a platform, you should spend time to get yourself acquainted with the tools.
Trading Chart, the User Interface, a Trading Lab of some sort, Scanner, alert features and notification mechanisms.
Below is a view of the E*TRADE platform as it stands at the time of this writing.
What is the FINRA Rule 4210 ?
As part of setting up an online account, brokers sometimes tout the Margin feature of the account.
A margin account provides the flexibility to increase the trader’s Buying Power (BP).
Let’s consider an example where trader Joe or Joanne opens up a brand new account with an initial deposit of X dollars.
Joe’s Margin account will provide Joe with a Buying Power of 4X to 6X dollars,.
Therefore making Joe/Joanne feels as if he/she actually has deposited 4X to 6X dollars.
This is one Leverage brokerage firms can provide.
There is sometimes a minimum amount Joe/Joanne needs to deposit in order for this feature to come in. Typically, $2000 can be such minimum threshold.
Now, to engage in day trading (activity of buying and selling the same security in the same trading day,
FINRA (formerly National Association of Securities Dealers, Inc. or NASD) Rule 4210 (Approved by the Securities and Exchange Commission on February 27 2001) imposes that one must maintain at least $25000 in a margin account.
If not, such trader is restricted to no more than 3 round-trip (Buy and Sell count as one round-trip) day trades within five consecutive business days.
Solution to Overcome Low Starting Capital
In case one does not have $25000 to start an account, one cannot do much of day trading ?
Yes, You Can. And this is how.
You simply call your broker and ask them to remove the margin feature of the account.
As a result, the account becomes a Cash Only account where it is possible to Day Trade Options.
Of course, the amount of Cash a trader deposits determines its initial Buying Power.
However you will no longer have to worry about Day Trade restriction while you build up your account.
Once above $25000, it will make sense to switch it back to a Margin account.
Who are the Players
At this stage of your Online Stock Trading Basics Learning, It is important to review the big Picture.
For any trade in the market, there are always two sides of the trade.
Just like buying a house type of transaction.
There is the Seller who desires to sell at the highest price and the Buyer who aims to buy at the lowest price.
In the world of stock and options trading, Market makers are those who write the Options.
These are usually big banks like Goldman Sachs and some brokers like the very one providing the platform you may be trading on.
In this last instance, talk about a conflict of interest (…)
The point here is that the Market Makers control the Bid (price at which Buyers want to buy) and the Ask (price at which Sellers want to Sell).
The distance between the Ask and the Bid (Ask – Bid) in dollars is the Spread.
Very Liquid Options tend to have very small Spread (less than 5 cents) whereas not so liquid Options tend to have bigger Spread (15 cents and above).
The liquidity of a stock Option is proportional to its volume.
The volume directly impacts the Open Interest (number of contracts currently held).
To Sum up, we offered you a path on How to Learn to Trade Options.
It starts with basic readings essentials and setting up a demo/paper trading account.
Then setting up a non-restricted (regardless of your initial capital) live options trading account.
Next, we shall tackle on the very instrument we seek to trade by answering the question: What is an Option ?