How to Profitably Trade Options (the Easy Way)

By Nate Bear

Options sound scary to many, and they intimidate many new investors. But they’re just as easy to understand and use as stocks and bonds…

So easy, in fact, that anyone can trade them…

Even if you’ve never invested in anything in your entire life.

If you’re completely mystified by options and have no idea where to begin, start here…

By the time you’re finished reading this guide, you’ll be well on your way to being an options trading pro.

And you’ll be ready to dive headfirst into trading along with me.

What you’ll find is that options are no harder to effectively use than stocks. But they do offer the opportunity for bigger, faster gains along with the ability to put far less money at risk.

However, they are more volatile than stocks, and that’s largely why they have a scary reputation. They can move down just as quickly as they shoot up, so you shouldn’t bet your retirement on a single play.

But in reality, their volatility is their strength. Options are a great way to leverage the market and amplify the moves of stock prices fivefold, tenfold or even more, no matter which way they move.

In this guide, you’ll learn everything you need to know, from understanding what an options contract is to how to place a trade. To begin, let’s answer this question: What exactly is an option?

What Is an Option?

In short, an option is a contract.

It’s one that gives its holder the right – but not the obligation – to buy or sell 100 shares on a designated date at a specified price, called the strike price.

There are two varieties of options – calls and puts.

A call option, or a call, is a contract that gives its holder the right – but not the obligation – to buy shares at a certain price.

It’s essentially a bet that the price of the underlying stock will rise above the option’s strike price by expiration, and the contract will give its owner the ability to buy at a discount.

When that happens, the call is referred to as “in the money.” If a call option’s strike price is above the price of its underlying security, it’s referred to as “out of the money.”

A put option, or a put, is the opposite of a call.

It is a contract that gives its holder the right – but again, not the obligation – to sell shares at a predetermined strike price.

It’s a bet that the price of the underlying stock will sink below the option’s strike price, and the contract will give its owner the ability to sell at a premium.

But here’s the trick: We’ll rarely exercise the right to buy or sell shares in Profit Surge Trader.

That’s right… We never have to own a single share of stock to make huge gains from options. More often than not, we’ll simply buy the option (or set up an option strategy), watch the price of its underlying asset rise or fall, and then get out before it expires.

Now let’s take a look at an option listing and dissect it so you can identify the ones I recommend…

This is an Apple call expiring in June. Monthly options usually expire on the third Friday of the month.

The number after the date – 185.000 – tells us the strike price is $185. Because this is a call, it’s a bet that Apple’s share price will exceed $185 by the expiration date.

At time of writing, Apple is sitting at about $187, so the option is called “in the money” (more on that later).

Simple enough, but now we have to discuss one of the details about options that confuses many new investors…

Let’s say these options are listed at a price of $2.68. Each option contract represents 100 shares of its underlying stock. That means $2.68 is the per-share premium. The actual price you’ll pay is $268, or $2.68 multiplied by 100.

To buy 100 shares of Apple stock without options at the price as of this writing ($187), you’d have to lay out $18,700. The option costing only $268 is a pretty great bargain by comparison.

Options are essentially a tool to magnify movements in the stock market.

For example, if the value of an option’s underlying shares moves just 5% to 10%, the options associated with it could move by 50%, 100% or even more.

Here’s how things might work with our Apple play. Let’s say we buy in for $2.68 and Apple is sitting at $190 on the expiration date. That’s $5 above our strike price, so we can exercise our option and buy 100 shares at a discount of $5 per share. We also could’ve sold our options before expiration (4 p.m. on the expiration date) for $5.68, or $568 for the contract. That would’ve given us a 111% return on our $268 investment.

Now, say we had bought 100 shares of Apple outright at $185 and sold at $190. That’d be a gain of 2.7%, or $500. Our dollar-value return is much lower with the option, but we put considerably less money at risk – less than 1% of the cost for 100 shares at market.

We were in for just $268, while stock investors would’ve been in for $18,700 (if they had bought at the market value at the time of writing). That means if our trade had gone south and Apple plummeted, we would’ve been out just $268 when our calls expired worthless. On the other hand, stock investors using a customary 25% trailing stop could have lost as much as $4,675, or 25% of their $18,700 investment.

That’s a lot of information to take in, but the more of this guide you read, the more options will make sense.

What’s Going on With Options Pricing?

Buying options is really no different from buying stocks, at least in terms of how you do it. Most online brokers will let you trade them. You don’t need some special permit or title, just a Level 2 or higher trading account, which is not difficult to get. (I’ll discuss this more below.)

Once you’ve set up your brokerage account to trade options, in almost every case, it’s as simple as clicking “Buy” or “Sell.”

But there are some more key terms to understand before you can trade options effectively.

First, what makes up the price of an options contract?

Well, there are two parts to it. The number you see next to the option listing is its premium (the $2.68 in our Apple example). That’s the amount you pay for each contract, which means you multiply it by 100 to get the value of the whole contract. The important thing to note is that the per-share price of an option is almost always significantly lower than the price of the stock that it tracks.

An option’s premium is made up of two factors: the option’s intrinsic and extrinsic value.

Intrinsic value is the difference between the current share price and the strike price.

For example, let’s say you bought a Company X call for $1.50 per share. The strike price of the option is $50, and the stock is currently trading for $48. Right now, your call is out of the money. It has no intrinsic value whatsoever.

However, if the stock price ticks up, say to $55, your option will shoot up in value too. To find out how much, you subtract the strike price from the current share price ($55 minus $50). Your options now have an intrinsic value of $5.

With the intrinsic value, we can also understand how much the share price needs to move before we can profit. To do that, we add the price of the premium to the strike price.

In the case of our example, that would be $1.50 plus $50, which equals $51.50. That means our breakeven price is $51.50, and any share movement higher will give us a profit.

Now, say the share price leaps up to $60. Then the intrinsic value of our option will leap to $10 ($60 minus $50). It would be even more with the extrinsic value included, but that’s a bit more difficult to calculate.

That leaves us with a 566% gain. That’s a serious winner, but I have seen even bigger. It’s not a frequent occurrence, but it illustrates the sorts of returns you can potentially make with options.

The remaining value of an option premium is its extrinsic value. It’s also referred to as the time value of the option. It’s made up of implied volatility, which fluctuates along with market demand for options, as well as days to expiration. The market price of an option minus the intrinsic value gives you the extrinsic value.

Extrinsic value decreases the closer you get to the option’s expiration date. So how does all this work?

Well, let’s take our Company X example…

Say we buy in at $1.50.

If the share price doesn’t move, the extrinsic value, or time value, of $1.50 will slowly degrade to $0 at expiration.

That’s because the extrinsic value is all about potential. It’s based on the chance the underlying stock has of moving up or down.

As such, the closer to expiration an option gets, the less chance there is for its underlying stock to move and the less potential the option has of being in the money.

That’s why you should always set a clear exit strategy before buying an option. You can’t rely on the option’s potential forever, and you don’t want to be left holding the bag when it expires.

That said, there is somewhat less risk with buying options in the sense that there’s less money on the table.

You position yourself to reap massive gains while putting less money at risk.

How Does the Options Market Work?

Now that you understand what goes into the price you pay for an options contract, let’s talk about how the market buys and sells options.

Each options contract has a bid price and an ask price. They’re also known as the bid and offer. It’s a two-way price quotation that illustrates the best-shown price at which the option can be bought or sold at any given time. It is very possible to trade at a price different from what is shown in the bid/ask market.

The bid price represents the maximum price that a buyer is willing to pay for an options contract. The ask price, or offer price, represents the minimum a seller is willing to take for the same options contract.

A trade can occur only after the buyer and seller agree on a price for the option, which is at or between the bid and the ask prices.

The difference between the bid and the ask is called the spread. The smaller an option’s spread, the more liquidity it has and the easier it is to trade.

To the average investor, the bid and ask spread is an implied cost of trading.

For example, if you’re looking at an option that reads $1.00/$1.05, someone looking to buy the option would pay $1.05 ($105), while the person selling it would receive $1.00 ($100) if they were to execute the trades at the current market prices.

So How Do I Actually Trade Options?

The process of actually buying and selling options is fairly simple, and it’s not too dissimilar from trading stocks. There are a couple of extra steps, but the bottom line is this: If you have an account and some money to trade with, you’re already (mostly) set.

You just have to contact your broker and let them know you’d like to trade options. You can do so either by using your already-existing account or by setting up an account specifically for options trading. To trade options, your account needs to be Level 2 to Level 5.

If you’re new to options trading, be sure to read all the material your broker sends you before you start trading. You should talk to your broker and have all your questions answered until you feel comfortable.

It might take some time to familiarize yourself with all the intricacies of options trading, but setting up an account to trade can be done in as little as five minutes.

If you don’t have a brokerage account, get one as soon as possible. Time is money – don’t waste it.

You can use any online brokerage to trade options. If you work with a full-service broker, that’s fantastic, but really, any of the big online ones will do.

Sometimes there will be fees. They will vary based on which one you use. Contact your broker to learn more about what it charges. Those charges can add up quickly if you’re doing fast-paced trading.

But these days, most major brokerages offer commission-free trading for stocks and options. Fidelity, Interactive Brokers, E-Trade, Merrill, J.P. Morgan, Webull, TD Ameritrade, Robinhood, Ally, Firstrade and Charles Schwab all offer commission-free trading. You might start with one of those if you’re looking for a broker that won’t eat into your gains.

Now, buying stock is simple. You just log in to your brokerage account, search by the company’s symbol or name, select the number of shares you want, and click “Buy.”

Buying options is just as easy, but there are a couple of extra steps. Start by looking up the options available for the stock you want.

When you’ve found your option, identified by its expiration date and strike price, click “Buy to open,” “Sell to close” or whatever is required to execute the strategy. I will give you the details on that for each trade.

There’s a bit more to it when we get into more complex strategies, but for your first basic options trade, it’s just that simple.

And don’t worry… we are here to help if you have more questions. And we can answer them live… in real time!

Remember, I go live each week at 12 p.m. ET on the Profit Surge Trader livestream platform and chat room.

I hope to see you there soon.

And welcome to Profit Surge Trader!