Options are contracts that give you the right to buy or sell stocks at specific prices before certain dates. You can purchase these contracts through most brokerage accounts, just like buying regular stocks.
Learning how to buy options properly requires understanding strike prices, expiration dates, and your profit goals before placing any trades.
Most beginners think options trading is too complex, but the buying process is straightforward once you know the basics. You choose between calls (betting prices go up) or puts (betting prices go down).
The key is picking the right contract that matches your market prediction and risk level.
Options can help you make money with less capital than buying stocks directly.
However, you can lose your entire investment if the stock doesn’t move in your favor before the contract expires. Getting educated on the fundamentals will help you avoid costly mistakes that new traders often make.
Calls Vs Puts Explained
Options contracts come in two main types: calls and puts. Each type gives you different rights with the underlying asset.
Call options let you buy an underlying asset at a set price. You purchase calls when you think the asset’s price will go up.
When you own a call contract, you can buy 100 shares at the strike price. This happens even if the market price is higher.
Put options work the opposite way. They let you sell an underlying asset at a set price.
You buy puts when you think the asset’s price will drop. The put contract gives you the right to sell 100 shares at the strike price.
| Option Type | Direction | Right Given |
| Call | Bullish (up) | Buy shares |
| Put | Bearish (down) | Sell shares |
Both calls and puts have expiration dates. You must use your rights before the contract expires.
The underlying asset stays the same for both types. Only your rights change based on which contract you choose.
Calls make money when prices rise above the strike price. Puts make money when prices fall below the strike price.
You can also sell calls and puts to other traders. This creates income but also creates obligations if the buyer uses their rights.
How To Pick The Right Strike Price
The strike price is the price at which you can buy or sell the stock when you exercise your option. This choice affects how much you pay for the premium and your profit potential.
In-the-money options have strike prices that are already profitable. Call options are in-the-money when the strike price is below the current stock price. Put options are in-the-money when the strike price is above the current stock price.
These options cost more in premium but have a higher chance of making money.
At-the-money options have strike prices very close to the current stock price. They offer a balance between premium cost and profit potential.
Out-of-the-money options have strike prices that are not yet profitable. They cost less in premium but need bigger stock moves to make money.
| Option Type | Premium Cost | Profit Potential | Risk Level |
| In-the-money | High | Moderate | Lower |
| At-the-money | Medium | Good | Medium |
| Out-of-the-money | Low | High | Higher |
Choose strike prices based on your market outlook. If you expect small stock moves, pick closer strike prices. If you expect big moves, you can choose strike prices further away.
Consider your budget too. Higher premium costs mean you need bigger moves to break even. Lower premium costs give you more room for profit but require larger stock moves.
Expiration Date Selection
The expiration date is when your option contract ends. You must decide how much time you want before the option expires.
Short-term options last 1-4 weeks. These cost less money but give you less time for the stock to move. They work best when you expect quick price changes.
Medium-term options last 1-3 months. These give you more time but cost more money. Most new traders choose these because they balance cost and time.
Long-term options last 6 months or more. These are the most expensive but give you the most time. They work well for big stock moves that take months.
Time Decay Factor
Options lose value as they get closer to expiration. This happens faster in the last 30 days. Pick dates that give you enough time for your trade idea to work.
Cost Comparison
| Time Period | Cost | Risk Level | Best For |
| 1-4 weeks | Low | High | Quick moves |
| 1-3 months | Medium | Medium | Most trades |
| 6+ months | High | Low | Long trends |
Avoid buying options that expire in less than 7 days. These lose value very fast and are hard to predict.
Pick expiration dates at least 30-45 days away when you start trading options. This gives you time to learn and make mistakes without losing money too quickly.
Break-Even Calculation
Your break-even point shows where you need the stock price to move to avoid losing money on your option. This calculation helps you decide if an option trade makes sense.
For call options, you calculate break-even by adding the premium you paid to the strike price. If you buy a call with a $50 strike price for $2, your break-even is $52.
For put options, you subtract the premium from the strike price. A put with a $40 strike price that costs $1.50 has a break-even of $38.50.
Call Option Break-Even Formula: Strike Price + Premium = Break-Even
Put Option Break-Even Formula: Strike Price – Premium = Break-Even
The stock must reach your break-even price by the time you exercise or sell the option. If the stock price stays below break-even for calls or above break-even for puts, you lose money.
Break-even calculations become more complex when you use options to hedge other positions. You need to factor in gains or losses from your existing holdings.
Some traders sell options before they expire instead of waiting to exercise them. In these cases, your actual break-even might be different from the calculated amount.
Always know your break-even before buying any option. This number tells you exactly how much the stock needs to move for your trade to be profitable.
When To Take Profits
Taking profits on options trades requires clear rules. Most successful traders set profit targets before they buy.
Set a profit percentage goal. Many traders take profits when they make 25% to 50% on their options. This helps lock in gains before the market turns.
Watch time decay closely. Options lose value as they get closer to expiration. Take profits when you have them, especially if expiration is near.
Consider these profit-taking signals:
- Your option doubled in value
- You reached your target profit
- The stock moved in your favor quickly
- Volatility dropped after you bought
Don’t get greedy. Small consistent profits beat waiting for huge gains that might never come.
Use trailing stops. This lets your profit run while protecting against big losses. Set the stop at 20% to 30% below your highest profit.
Take partial profits. Sell half your position when you hit your first target. Keep the rest for bigger gains.
The key is having a plan before you trade. Know when you will sell for a profit. Stick to your rules even when emotions tell you to hold longer.
Buying Mistakes
New traders often make costly errors when buying options. These mistakes can quickly drain your portfolio and create large losses.
Buying options close to expiration is a common mistake. Time decay works against you fast. Your option loses value every day it gets closer to expiring.
Many traders risk too much money on single trades. Options can expire worthless. Never put more than 5% of your portfolio into one option trade.
Not understanding volatility causes problems. High volatility makes options expensive. Low volatility makes them cheap but less likely to move.
Some traders buy options without knowing basic leverage risks. Options can multiply gains and losses. A small stock move can create big option profits or losses.
Common Options Trading Mistakes:
- Buying options on the expiration day
- Not setting stop losses
- Choosing the wrong broker with high fees
- Buying out-of-the-money options that are too far away
- Not checking bid-ask spreads before buying
Ignoring your broker’s fees eats into profits. Some brokers charge high commissions for options trading. Shop around for better rates.
Many traders don’t plan their exit strategy. Know when you will sell before you buy. Set profit targets and loss limits ahead of time.
Buying too many contracts at once increases risk. Start small while learning. You can always buy more options later as your skills improve.
