In this article we discuss how much money can you make trading options, as well as what options are, their purposes, how options are traded and the risks. We will also define some other terms like calls and puts and provide some real examples of how much money can you make trading options.
Trading Options Definition
With no Requirement to Buy or Sell, Options are Derivative Contracts Traded on a Limited Time Basis
“Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to.” –Investopedia
Although the price of the option is based upon stock value, the option is a contract that is not directly linked to the stock value in the market. Additionally, options are considered derivative investments. Moreover, the option does not represent ownership of stocks or assets until the agreement is finalized.
Equally important, options are commonly traded in denominations of 100 shares of a company. The options contract will be written in a way that allows the buyer or seller to lock in a buy/sell price at some point in the future. However, it’s important to note that when the contract expires at the end of its expiration date, it is worthless. In our discussion of how much money can you make trading options, we will attempt to clarify some of the mysteries of stock options trading.
Types of Options Contracts: Call and Put
First, when considering how much money can you make trading options, it is important to understand calls and puts. There are two types of options: call options and put options. A call option, also known as an exercise price or strike price, is a contract that determines what price at which the buyer can purchase the option in the future. In contrast, a put option is a contract that determines what price at which the buyer can sell the option in the future.
In addition, call and put options contracts can expire along different time frames. The expiration time frames for contracts can vary from weekly, monthly or several months. Obviously, the longer the length of a contract, the more it costs per stock. Contracts are usually denominated in lots of 100 shares.
Call Option Example
A Call Option is Exercised for a $1,500 Profit
As an example, let’s assume that Tesla is trading at $400 per share. In some cases, the options price will be quoted per stock over a 30-day period. For example, call options might be priced at $5 per share of stock (premium). In this case, the options contract would be $500 (100 shares X $5 per share = $500 contract).
Let’s say that you anticipate the price of Tesla rising to $420. On day 21 of the contract, Tesla meets your expectations and rises to $420. You then exercise your contract and your profit from the trade is $1,500. The math is demonstrated below.
420-$400 = $20 per share increase in value
$420 – ($400 strike price + $5 premium) = $15 realized (nominal) per share profit
$15 per share profit X 100 shares = $1,500 profit
Why Use Options Trading
When thinking about how much money can you make trading options, you should understand why we use options trading. Options trading has traditionally been used by Wall Street traders as a hedge against risk. Options contracts can be used as a kind of insurance to counter balance a trader’s portfolio.
History of Options
Options trading has not been around for very long, compared to the history of the New York Stock Exchange. According to Optiontradingpedia.com, options trading began at the Chicago Board of Options Exchange (CBOE) in 1973. Yet, the New York Stock Exchange was founded in 1792 in New York City.
With the continued movement for deregulation of the financial industry in the past 25 years, options trading has become more popular with retail traders.
Difference Between Options and Futures
Options Contracts Require no Action Upon Expiration; Futures Contracts Require Traders to Buy or Sell Upon Expiration
The primary difference between options contracts and futures contracts is that with options contracts the trader is not required to buy or sell at any time. The trader simply has the “option” to buy or sell shares in a stock. Whereas, futures contracts require the buyer to buy shares of a stock and the seller to sell shares of a stock upon expiration of the contract.
Both Options and Futures can be used to hedge against risk incurred in a portfolio of investments. For example, if you have a portfolio of tech stocks that are considered long investments, then you might purchase options to hedge against a price collapse of the holdings.
The Risks of Option Trading
Option Trades Can Be Highly Volatile and Are Not Recommended for New Investors
It’s important to understand that trading options is inherently risky. Unlike purchasing assets like stocks or bonds, options contracts are short term derivative instruments that have no real value. In addition, the contract expires in a matter of weeks or months. If the options contract expires and is not exercised, it is worthless.
Legendary investor Peter Lynch of Fidelity Investments had this to say regarding options trading:
“I know that the large potential return is attractive to many small investors who are dissatisfied with getting rich slow. Instead, they opt for getting poor quick. That’s because an option is a contract that’s only good for a month or two, and unlike most stocks, it regularly expires worthless – after which the options player must buy another option, only to lose 100 percent of his or her money once again.” -Peter Lynch of Fidelity Investments, Once Upon a Time on Wall Street
In case you didn’t follow that quote, Peter Lynch is not a fan of options trading.
Options Trading Tragedy
In June 2020, a 20-year-old student named Alexander Kearns who used the Robinhood mobile app to trade options committed suicide. Apparently after entering a trade, Mr. Kearns saw a -$730,000 balance displayed on his account and believed that he had lost a great deal of money. It is believed that he took his own life as a result of the confusion. As a result, Robinhood has allegedly made modifications to the trading app to prevent future confusion among traders.
Thinking and planning for the future are noble activities that we encourage at Piggy Bank Coins. Every adult should learn to budget, save money and invest at some time in their life. If you have a family, it is critical that you begin planning your financial future.
Despite its growing popularity, learning how much money can you make trading options is not recommended for most investors. We recommend a more fiscally conservative approach of slow, incremental saving and wealth building. Read more about what Piggy Bank Coins recommends at the links below.
Learn More About Making Money Using Option Trades
Hopefully our discussion and explanation of how much money can you make trading options has helped you understand options. If you are truly determined to learn more about how much money can you make trading options, check out the book “Trading Options for Dummies” or read more about options trading on this website.
It is important to note that Piggy Bank Coins does not provide financial advice. We do not endorse or recommend any financial investments. Instead, we provide information for educational purposes to those seeking knowledge regarding personal finance. However, in the spirit of transparency, note that the author is an investor in cryptocurrencies, precious metals and some equities.
In addition, The Federal Trade Commission (FTC) requires that Piggy Bank Coins disclose to readers that we may receive commissions when you click our links and make purchases. However, this does not impact our reviews and comparisons. Moreover, we try our best to keep things fair and balanced, to help you make the best choice for you.