How to Trade Options in Just 4 Simple Steps

Options trading involves buying or selling contracts ("options") that give you the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (the "strike price") by a specific date (the "expiration date").

For example, assume you want to buy 100 shares of a stock that currently costs $50 per share. You could purchase an option contract that gives you the right to buy those shares for $60 each within the next three months. 

This contract might cost you $500. If, at some point in those three months, the price of the stock jumps to $80 per share, you can exercise your option to buy the shares for $60, then immediately sell them for $80, making a profit of $20 per share, or $2,000 total (minus the $500 cost of the contract and any trading fees).

Here's a table summarising the key differences between options trading and stock trading:

>> Read: A guide to options trading

Options trading is generally more suitable for advanced investors with a good understanding of financial markets and investment strategies. It requires careful analysis, risk management and a willingness to actively monitor your positions. If you're a beginner to investing, have little money to invest or prefer a more passive trade approach, do consider carefully as options trading might not be the best fit for you. 

>> Read: How and where to start investing in Singapore

Before you can begin trading options, you'll need to open an options trading account with a brokerage firm. This process is typically more involved than opening a regular brokerage account, as it requires demonstrating your understanding of options trading and your financial capacity to handle potential risks.

Here's what you need to know about opening an options trading account:

• Brokerage requirements: Brokerage firms usually have specific requirements for approving options trading accounts. These may include:

  • A minimum account balance.

  • A margin account to cover potential losses.

  • Passing an aptitude test to assess your knowledge of options trading.

Once you meet these requirements, you'll likely be assigned a trading level based on your risk profile. This level determines the types of options trades you are allowed to execute. Higher-risk trades, such as uncovered options, may be restricted to more experienced traders.

>> Read: Best trading brokerage accounts and platforms in Singapore

Choosing the right broker is crucial for successful options trading. Consider factors such as:

• Capital requirements: Ensure the broker's minimum balance and margin requirements align with your financial capacity.

• Research and educational resources: Access to comprehensive research, educational materials and trading tools can help you make informed decisions.

• Fees and commissions: Compare the fees charged by different brokers for options trades, as these can significantly impact your profitability.

• Trading platform: Choose a broker with a user-friendly and reliable trading platform that suits your needs and preferences.

• Customer support: Access to responsive and knowledgeable customer support can be invaluable, especially for new options traders.

Remember, options trading involves significant risks, and it's essential to choose a broker that provides the necessary support and resources to help you navigate the complexities of the market.

>> Read: Best SG stocks investment brokerage accounts in Singapore

Once you have an options trading account set up, the next step is to determine which options to buy or sell. This decision hinges on your market outlook and whether you anticipate the price of the underlying asset to rise, fall or remain relatively stable.

Here's a breakdown of the two main types of options:

• Call options: A call option grants you the right to buy the underlying asset (e.g., a stock) at a predetermined price (strike price) before a certain expiration date. You'd buy a call option if you believe the asset's price will go up. Conversely, you'd sell a call option if you anticipate the price will go down or remain stable.

• Put options: A put option grants you the right to sell the underlying asset at a predetermined price before the expiry date. You'd buy a put option if you predict the asset's price will decline. On the other hand, you'd sell a put option if you expect the price to rise or stay flat.

For those new to options trading, it's generally recommended to start with simpler strategies, such as buying calls or puts. These strategies are easier to understand and manage, allowing you to gain experience and confidence before venturing into more complex options trading techniques.

In options trading, you're essentially making a bet on the future price of the underlying asset. The strike price, or the predetermined price at which you can buy or sell the asset, is a crucial element of this bet. It plays a significant role in determining the potential profitability of your trade. If the asset's price moves favourably and crosses the strike price, your option will be "in the money," potentially leading to profits. However, if the price moves against your prediction or doesn't reach the strike price, your option could expire worthless, resulting in a loss.

Choosing the right strike price requires careful analysis and consideration of your market outlook, risk tolerance and the timeframe of your trade. If you're optimistic (bullish) about the asset's price, you might choose a strike price above the current market price, anticipating a rise. Conversely, if you're pessimistic (bearish), you might select a strike price below the current price, expecting a decline.

Understanding options pricing fundamentals, such as intrinsic value and time value, can further aid your strike price selection. Intrinsic value represents the immediate profit if you exercised the option now, while time value reflects the potential for increased profitability before expiry. By considering these factors, you can make informed decisions about strike prices and options pricing, increasing your chances of successful trades.

Every options contract comes with an expiration date, which is the last day you can exercise your right to buy or sell the underlying asset. When trading options, you'll need to select an appropriate expiration date that aligns with your investment strategy and risk tolerance. Options contracts have varying expiration dates, ranging from short-term (e.g., daily or weekly) to long-term (e.g., monthly or yearly). 

The expiration date you choose can significantly affect your options trading strategy. For instance, if you're confident about a short-term price movement, you might opt for a shorter-term option to capitalise on the immediate price swing. However, if you have a longer-term outlook, a longer-term option would be more suitable. 
Short-term options are generally riskier but offer the potential for higher rewards if your predictions are accurate. On the other hand, longer-term options provide more time for your investment thesis to play out, but they may come with a higher premium cost.

Read on as we walk you through the process of buying a call or put, from understanding the basics to mastering advanced strategies.

Let's say the current share price of SingTel is S$2.50. You believe the price will rise to S$3.00 in the next month. To capitalise on this, you could buy a call option with a strike price of S$2.70, expiring in one month. The premium for this option might be S$0.10 per share.

If SingTel's share price rises to S$3.00 or higher by the expiry date, your option will be "in the money." You can then exercise your option to buy the shares at S$2.70 and sell them at the market price of S$3.00, making a profit of S$0.30 per share (minus the premium and any transaction fees).

However, if the share price doesn't reach the strike price of S$2.70 by the expiry date, your option will expire worthless, and you'll lose the premium you paid (S$0.10 per share).

Let's say you believe that the price of DBS Group Holdings shares, currently trading at S$30 per share, will decline to S$25 in the next two months. To profit from this anticipated price drop, you could buy a put option with a strike price of S$28, expiring in two months. The premium for this option might be S$1 per share.

If DBS's share price falls below S$28 by the expiry date, your option will be "in the money." You can then exercise your option to sell the shares at S$28, even though the market price is lower, and make a profit. For instance, if the share price drops to S$25, you'll profit S$3 per share (minus the premium and transaction fees).

However, if the share price remains above S$28 by the expiry date, your option will expire worthless, and you'll lose the premium you paid (S$1 per share).

Options trading offers several advantages that can enhance your investment strategy and potentially boost your returns. One key benefit is the ability to hedge against potential losses in your stock portfolio. By using options, you can essentially "insure" your holdings against price declines, limiting your downside risk. 

Additionally, options trading allows you to participate in the market with a lower capital outlay compared to traditional stock trading. This can be particularly appealing for investors with limited funds who still want to gain exposure to various assets.

Furthermore, options trading provides the potential for amplified profits. Due to the leverage inherent in options contracts, even small price movements in the underlying asset can translate into significant gains. This can be an attractive proposition for those seeking higher returns, though it's essential to remember that losses can also be amplified. 

Finally, options trading offers greater flexibility compared to stock trading. You have the option to exercise your contracts, sell them to other investors or even let them expire, depending on market conditions and your investment goals. This versatility can be a valuable tool for sophisticated investors seeking to fine-tune their portfolios and capitalise on various market opportunities.

>> Read: Best investment sign-up promotions in Singapore 

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