How to Trade in Options Online

By Matt Krantz from Investing Online For Dummies, 7th Edition

One way to invest money online is to buy options. If you own an option, you have the right, but not the obligation, to buy or sell an investment, including shares of stock by a certain preset time in the future. Options can be extremely powerful in the right hands, and they can either help you boost your returns or reduce your risk, depending on how you use them.

If used prudently and safely, options can remove perils in the way of your financial goals. But if abused, misunderstood, or used recklessly, options can blow your financial plan to smithereens.

When you own an option, you have the power to make someone follow through on a trade for an underlying asset, such as a stock, no matter what happens to the price. Options expire on the third Friday of every month.

Two types of options exist:

Calls give their owners the right to buy a stock at a certain price at a certain time (in the future. One call contract gives you the right to buy 100 shares of the underlying stock.
Puts give their owners the right to sell a stock at a certain price at a certain time in the future. One put contract gives you the right to sell 100 shares of the underlying stock.

The real beauty of call and put options kicks in because you can either buy or sell them to other investors. That gives you four distinct strategies:

Buying a call: When you buy a call, you have the right to force someone to sell you the stock at the exercise price you agreed upon ahead of time. You make money on a call when the stock price rises above the exercise price. This strategy is for investors that are convinced a stock will rise and want to bet big. Buying a call isn’t free. You must pay the seller for the option, in the premium.
Selling a call: When you sell a call, you’re on the other side of the option strategy of buying a call. You get paid the premium and pocket the money. If the stock falls, you keep that money free and clear. But if the stock rises, you’re in trouble because you’ve agreed to sell the stock for the lower price.

You should never sell a call unless you know what you’re doing. If you sell a call and don’t own the underlying stock, that’s called writing a naked call. If the stock rises, your losses are unlimited because in theory the stock could rise hundreds of points.

If a call sounds like something you’d like to trade, here are places online where you can find out more:

When you buy a put, you have the right to make someone buy a stock from you for a prearranged price. You’re betting that the price of the underlying stock will fall. And like buying a call, it lets you make a big gamble with little up-front money. It’s another way to bet against a stock, similar to shorting a stock.

This strategy places you on the other side of the person who is buying the put. When you sell a put, you’re usually betting that the price of the underlying stock will rise. But you might also sell a put if you’re willing to buy the stock at the current price but think it might go lower in the short term. That way, if the stock does fall, you must buy the stock at the higher exercise price but get to keep the premium.