Understanding options

Learn about the basic components of the two types of options contracts—calls and puts—and why you would want to consider incorporating them into your trade plan. 

What are options?

An option is a contract that gives the purchaser the right to buy or sell a financial product at an agreed upon price for a specific period of time. 

Options are available on numerous financial products, including equities, indices, and ETFs. Options are called “derivatives” because the value of the option is “derived” from the underlying asset. 

When you trade stock, you exchange ownership in a company. By contrast, when you buy or sell option contracts, you are trading the potential, or obligation, to buy or sell the underlying stock. Owning an option, in and of itself, does not impart ownership in the underlying security, nor does it entitle the holder to any dividend payments. 

Why trade options?

While some options strategies can be complicated, the ones that make sense for most investors are often relatively straightforward. 

Simple options strategies can potentially help you: 

  • Hedge against risk or generate income. 
  • Speculate with bullish, bearish, and neutral strategies. 
  • Develop strategies based on time, volatility, or interest rates. 
  • Lower your breakeven point.
     
Female options trader using a laptop on a couch Female options trader using a laptop on a couch Female options trader using a laptop on a couch

Calls versus puts

Calls
A call option gives the contract owner/holder (the buyer of the call option) the right to buy the underlying stock at a specified price by the expiration date Tooltip . Calls are typically purchased when you expect that the price of the underlying stock may go up.

Puts
A put option gives the contract owner/holder (the buyer of the put option) the right to sell the underlying stock at a specified price by the expiration date. Puts are typically bought when you expect that the price of the underlying stock may go down.
 

Calls versus Puts Chart Calls versus Puts Chart Calls versus Puts Chart

Here are the basic steps involved in the options trading process.

1.    Determine your objective.

  • Income generation

    Options can be used to potentially generate income on stocks you own and stocks you would like to own. 

  • Hedging

    Options can be used to reduce the risk on an existing stock position.

  • Speculation

    Options allow you to take a speculative market position using leverage. You can even create a position that potentially profits if the market stays neutral. 

2. Search for options ideas.

2. Search for options ideas. 

Now that you've identified your primary objective, what other characteristics of an option or underlying security are you looking for? Filtering the field based on price, volume Tooltip , implied volatility Tooltip , sector, or other parameters can narrow the universe of trades down to a manageable set of ideas. 

Screener screenshot Screener screenshot Screener screenshot

3. Analyze and compare ideas.

3. Analyze and compare ideas. 

Once you've found a few options trade ideas, it's time to compare them. You can start by analyzing each option's potential risk or reward, as well as how its price may be impacted by factors like changes in the underlying stock price, days to expiration, different strike prices Tooltip  and expiration dates Tooltip , and implied volatility Tooltip

Trade & probability calculator screenshot Trade & probability calculator screenshot Trade & probability calculator screenshot

4. Place your options trade.

4. Place your options trade. 

The next step is to establish your option position by submitting an order for execution through your online broker. Choose the underlying symbol, then enter the specific option order details (price, number of contracts, opening/closing, etc.). Once your order is submitted, it will be routed to the market.
 

All-in-One Trade Ticket screenshot All-in-One Trade Ticket screenshot All-in-One Trade Ticket screenshot

Common options strategies.

Common options strategies.
  • Objective 
  • Outlook 
  • Strategy 
  • Description
  • Objective 
    Income generation 
  • Outlook 
    Neutral to bullish 
  • Strategy 
    Covered Call 
  • Description
    Sell a call against an existing stock position
  • Objective 
    Income generation 
  • Outlook 
    Neutral to bullish 
  • Strategy 
    Cash-Secured Equity Put
  • Description
    Sell a put, secured by cash set aside in case of assignment
  • Objective 
    Hedging 
  • Outlook 
    Neutral to Bearish 
  • Strategy 
    Protective Put
  • Description
    Buy a put on an existing stock position
  • Objective 
    Speculation  
  • Outlook 
    Either direction 
  • Strategy 
    Straddle 
  • Description
    Buy a call and a put at the same strike
  • Objective 
    Speculation  
  • Outlook 
    Either direction 
  • Strategy 
    Debit Spread
  • Description
    Buy and sell calls with different strike prices and/or expirations, or buy and sell puts at the same time

Why trade options with Schwab?

  • US$0.65 option contracts¹

    Online options trades at Schwab have no base commission and low per contract fees. 

  • Intuitive platforms

    Plan and execute strategies on the convenience of web, mobile, or advanced software. 

  • Options specialists

    Get real-time trade analysis and focused support from options professionals during trading hours. 

  • Powerful tools

    Find, analyze, and act on options trading ideas with our premier tools. 

Start investing in the U.S. today.

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