How does options trading work?
Options are contracts that let investors speculate on the future price of something, typically stocks. In its simplest form, an options contract lets — but never requires — the options buyer to purchase or sell stocks at a predetermined price by a set date. If the buyer decides to exercise their contract, the seller must follow through.
Options can be broken down into two basic types:
- Call options: Call options let options buyers buy stock at a predetermined price (the “strike price”). When investors buy call options, they’re often speculating that a stock’s price will rise before the options contract expires. If they’re right, they can buy their shares of the stock at the lower strike price.
- Put options: Put options let options buyers sell stock at an agreed-upon strike price. When investors buy put options, they’re often speculating that a stock’s price will fall before the options contract expires. If they’re right, they can sell their shares of the stock at the higher strike price.
To understand these basic types, let’s look at two examples.
Let’s assume Stock AB has a share value of $50. You have good reason to believe Stock AB will appreciate by 20% over six months and will at that time be worth $60 a share. To act on that belief, you could buy 100 shares of Stock AB for $5,000. Or, if you didn’t want to wager $5,000, you could buy call options of $50 for $2 a pop (or $200 total for 100 shares).
If you’re right and the stock appreciates to $60 within six months, you would earn $10 on each option, for a total of $1,000. Minus the $200 you paid for your options, you’d be left with a profit of $800. Not bad for an initial investment of $200.
Now, let’s assume another investor comes along and believes Stock AB will depreciate over six months. In this case, they could buy a put options contract with a strike price of $60 for $2 a share and 100 shares total (or $200). If they’re right and the stock falls to $36, they would make $24 a share for a total of $2,200 in profit ($2,400 minus the $200 for the put contract).
Features of the best options trading brokers
Options traders typically demand more of an options trading broker than people who are simply entering market or limit orders for stocks. Active option traders may prioritize options brokers based on their selection of calculators or screeners, whereas the infrequent options user may care about commissions alone.
Some features that may be considered “make or break” when picking the best platform to trade options are listed below:
- Commissions-free options trades: While price isn’t everything, what you pay to make a trade ultimately plays through to your profit or loss. It makes very little sense to place a trade where the only likely winner is the brokerage firm. Commissions have come down quite a bit in recent years, and most of the best brokers for option trading offer commission-free trading on stocks as well, but there’s still quite a bit of difference within the industry when it comes to options. Many of the best options trading brokers have commission-free options trading but may charge options trading fees per contract.
- Platform: Admittedly, the award for “best options trading platforms” is a little subjective. What makes a good trading platform often has more to do with personal preference than anything else, as placing a trade through any brokerage is usually a matter of a few clicks. Some traders may see a full-featured platform as an asset, while beginning investors may see the complex interface as a liability. It’s also important to note that some of the best options trading brokers offer a full-featured platform and an easier-to-use trading platform.
- Resources: Many of the best options brokers offer a full range of educational resources, which can be extremely valuable for investors who are new to options. As we mentioned, options can be very complex financial instruments and it is very easy to lose lots of money if you don’t know what you’re doing.
LEARN MORE: How to trade options
How do the best options trading platforms compare on trading fees?
Commissions and fees for options trades can vary wildly even among the best option trading apps, and the difference can really add up. Here’s a look at the costs associated with options trading, and how much our best brokers for option trading charge.
Most of the best options brokers have eliminated flat-rate commissions for online stock and options trading, and just use a small fee for certain options traded. That means they offer commission-free options trades, but charge a fee based on the number of options contracts traded. Thus, it costs more at most options brokers to trade 50 options contracts than it does to trade 10 options contracts.
The most common price point is roughly $0.65 per contract, although this can be between $0 and $1.00, depending on the stock options broker. Based on the typical fee of $0.65, to buy 10 contracts, a trader would pay $6.50 to make the trade ($0.65 × 10 = $6.50). To buy 100 contracts, the same trader would pay $65 in commissions to make the trade.
And to be clear, these are commissions for online options trades. If you conduct a trade by phone, the commission could be even higher.
The table below compares options trading platforms based on the cost to buy or sell 10 options contracts.
Options trading fee comparison for 10 contracts
Commission-free options trading used to be a pipe dream for investors, but that’s no longer the case with the best platforms to trade options slashing costs to attract and retain accounts. Here’s an options fee comparison when trading 10 contracts for our top picks: