Discover how to trade options in a speculative market

Learn the basics and explore potential new opportunities on how to trade options

The options market provides a wide array of choices for the trader. Like many derivatives, options also give you plenty of leverage, allowing you to speculate with less capital. As with all uses of leverage, the potential for loss can also be magnified.

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Explore the information and resources below to learn how to trade options. If you have questions along the way, contact a specialist  for help.

Understanding the Basics

A long option is a contract that gives the buyer the right to buy or sell the underlying security or commodity at a specific date and price. There is no obligation to buy or sell in the contract, but simply the right to “exercise” the contract, if the buyer decides to do so. An option that gives you the right to buy is called a “call,” whereas a contract that gives you the right to sell is called a "put." Conversely, a short option is a contract that obligates the seller to either buy or sell the underlying security at a specific price, through a specific date.  When the buyer of a long option exercises the contract, the seller of a short option is "assigned", and is obligated to act.

To make this clearer, let’s use a real world analogy… Let’s say you’re shopping for an antique grandfather clock and find the perfect one at the right price: $3,000. But you won’t have the cash for another three months. You talk to the owner and he agrees to sell it at that price in three months with a specific expiration date, but you have to pay $100 for him to agree to the contract. After three months, you have the money and buy the clock at that price.

But maybe it’s discovered that the clock was owned by Theodore Roosevelt, which makes it worth $10,000. You have the right to exercise your option and buy it for $3,000, netting you a profit of $6,900 (minus transaction costs). On the other hand, let’s say it’s discovered that’s it’s not an antique at all, but a knock-off worth only $500. You’re under no obligation to exercise your option and buy it at $3,000, so you can opt not to buy it at all and simply let the contract expire. Although you’re still out the $100, at least you’re not stuck with a clock worth a fraction of what you paid for it. From the option seller's perspective, in the first scenario he gets the $100, but is later forced to sell the clock at less than true market value.  In the second scenario, he keeps the clock, and the $100 you paid in premium.

If you understand this concept as it applies to securities and commodities, you can see how advantageous it might be to trade options. For a relatively small amount of capital, you can enter into options contracts that give you the right to buy or sell investments at a set price at a future date, no matter what the price of the underlying security is today.

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Trading Options

Some things to consider before trading options:

Leverage: Control a large investment with a relatively small amount of money. This allows for strong potential returns, but you should be aware that it can also result in significant losses.

Flexibility: Options allow you to speculate in the market in a variety of ways, and use a number of creative strategies. There are a wide variety of option contracts available to trade for many underlying securities, such as stocks, indexes, and even futures contracts.

Hedging: If you have an existing position in a commodity or stock, you can use option contracts to lock in unrealized gains or minimize a loss with less initial capital.

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Setting Up an Account

You can trade and invest in options at TD Ameritrade with several account types. You will also need to apply for, and be approved for, margin and option privileges in your account.

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Choosing a Trading Platform

With a TD Ameritrade account, you’ll have access to options trading on our web platform, as well as on our two more comprehensive platforms: Trade Architect, and thinkorswim. Trade Architect is ideal for those traders first starting with options. It features fundamental tools, such as P&L charts, option strategy chain filters, and other tools that can give you ideas and the ability to test your strategy.

playTrade ArchitectTrade Architect

The thinkorswim platform is for more advanced options traders. It features elite tools and lets you monitor the options market, plan your strategy, and implement it in one convenient, easy-to-use, integrated place. Also, if you plan on participating in complex options trades that feature three or four “legs,” or sides of a trade, thinkorswim may be right for you.

playthinkorswimthinkorswim

In addition, TD Ameritrade has mobile trading technology, allowing you to not only monitor and manage your options, but trade contracts right from your smartphone, mobile device, or iPad.

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Developing a Trading Strategy

Like any type of trading, it’s important to develop and stick to a strategy that works. Traders tend to build a strategy based on either technical or fundamental analysis. Technical analysis is focused on statistics generated by market activity, such as past prices, volume, and many other variables. Charting and other similar technologies are used. Fundamental analysis focuses on measuring an investment’s value based on economic, financial, and Federal Reserve data. Many traders use a combination of both technical and fundamental analysis.

Whether you use technical or fundamental analysis, or a hybrid of both, there are three core variables that drive options pricing to keep in mind as you develop a strategy:

  1. Price of the underlying security or commodity

  2. Time to expiration

  3. Implied volatility based on market influences and future outlook

With both Trade Architect and thinkorswim, you’ll have tools to help you analyze these variables and more. You’ll also find plenty of third-party fundamental research and commentary, as well as many idea generation tools. You can even “paper trade” and practice your strategy without risking capital. In addition, you can explore a variety of tools to help you formulate an options trading strategy that works for you. You can also contact a TD Ameritrade Options Specialist anytime via chat, by phone 866-839-1100 or by email 24/7.

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Building Your Skills

Whether you’re new to investing, or an experienced trader exploring options, the skills you need to profit from options trading should be continually developed. You’ll find Trade Architect, is a great way to start. For veteran traders, thinkorswim, has a nearly endless amount of features and capabilities that will help build your knowledge and options trading skills.

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playInvesting Basics: OptionsVideos
04:54Want to learn more about investing? The Investing Basics series provides an introduction to a variety of investing topics. Options are an alternative way for an investor to potentially profit from a security’s price changes. In this video, we explain how an options contract works and show you an example of what can happen when buying or selling options
ScreenersScreenersTools & CalculatorsAll
Stock, Mutual Fund, ETF, and Options screeners use the criteria you enter to find investments that may fit your strategy...
playInvesting Basics: Covered CallsVideos
2:57Covered calls are often the first strategy option traders use because they have the potential to create income using a stock or ETF they already own.
playthinkorswimVideos
01:27TD Ameritrade offers a powerful and intuitive trading experience through thinkorswim.
playTrade ArchitectVideos
01:30Turn your trading experience into an intuitive one with this robust, web-based platform - all without subscription fees, platform fees, or trade minimums.
playiPad®Videos
00:30Take a tour of our powerful iPad apps, built with our most advanced trading technology.

AdChoices

Market volatility, volume and system availability may delay account access and trade executions.

Educational resources are provided for general information purposes only and should not be considered an individualized recommendation or advice.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Past performance of a security or strategy does not guarantee future results or success.

TD Ameritrade, Inc., member FINRA  / SIPC  / NFA . This is not an offer or solicitation in any jurisdiction where we are not authorized to do business. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2014 TD Ameritrade IP Company, Inc. All rights reserved. Used with permission.