Options Trading 101

Options Trading 101

Introduction to Options Trading

Investing, Investing Strategy

Introduction to Options Trading

Investing, Investing Strategy
Male freelancer use notebook sitting in modern loft interior with big windows, confident business man busy using laptop at office desk, young student texting on computer while sitting at wooden table

Puts, calls, strike prices, premiums, derivatives, bear put spreads and bull call spreads — the jargon is just one of the complex aspects of options trading. But don’t let any of it scare you away.

Options can provide flexibility for investors at every level and help them manage risk. To see if options trading has a place in your portfolio, here are the basics of what options are, why investors use them and how options trading works.

What are options?

An option is a contract to buy or sell a stock, usually 100 shares of the stock per contract, at a pre-negotiated price and by a certain date.

Just like you can buy a stock because you think the price will go up or short a stock when you think its price is going to drop, an option allows you to bet on which direction you think the price of a stock will go. But instead of buying or shorting the asset outright, when you buy an option you’re buying a contract that allows — but doesn’t obligate — you to do a number of things, including:

  • Buy or sell shares of a stock at an agreed-upon price (the “strike price”) for a limited period of time.
  • Sell the contract to another investor.
  • Let the option contract expire and walk away without further financial obligation.

Options trading may sound like it’s only for commitment-phobes, and it can be if you’re simply looking to capitalize on short-term price movements and trade in and out of contracts — which we don’t recommend. But options are useful for long-term buy-and-hold investors, too.

Why use options?

Investors use options for different reasons, but the two main ones are to limit their exposure to risk on stock positions they already have and to make controlled speculative bets.

Let’s say you own stock in a company but are worried about short-term volatility wiping out your investment gains. To hedge against losses, you can buy an option (technically, a “put” option) that gives you the right to sell a particular number of shares at a predetermined price. If the share price does indeed tank, the option limits your losses, and the gains from selling help offset some of the financial hurt.

On the flip side, if there’s a company you’ve had your eye on and you believe the stock price is going to rise, a “call” option gives you the right to purchase shares at a specified price at a later date. If your prediction pans out you get to buy the stock for less than it’s selling for on the open market. If it doesn’t, your financial losses are limited to the price of the contract.

Here we’ll use a metaphor to explain the mechanics of how this works.

How options work

Two art collectors spot the work of a hot new artist in a gallery. The paintings — the stand-in for a stock in this example — are being sold for $500 each, and each collector predicts the market will soon be clamoring for this artist’s work and thus drive up prices.

One collector dives right in and forks over $500 to the gallery owner to take home a painting. The other one buys an option on a painting.

Buying an option requires a smaller initial outlay than buying the stock.

For a fraction of the $500 price tag, the option holder pays the gallery owner to hold onto the painting until a certain date. At this point, the collector doesn’t own the painting; he owns a contract that gives him the right — without any obligation — to buy the painting within a certain period of time for the agreed-upon price of $500.

An important caveat if you’re considering trading stock options in real life: Each option contract represents a minimum of 100 shares. So while the option contract may not cost much, if you decide to exercise the option and purchase the underlying asset, you’ll have to pony up enough to buy all 100 shares at the strike price.

An option buys an investor time to see how things play out.

If demand for the artist’s work heats up — let’s say prices rise to $600 — the collector who bought the painting outright for $500 is sitting pretty. She can either hold onto the asset and see if the value continues to increase, or she can sell it for a profit.

The option holder also is in a good place because, remember, he’s got a discount coupon in his back pocket. The option contract locked in the price of the painting at $500, and the gallery owner is obligated to honor the contract even though the going rate is now $600. The option holder can either choose to exercise the option and buy the painting for $500 or make a profit by selling the contract, which is now more valuable since painting prices on the open market have gone up.

An option protects investors from downside risk by locking in the price without the obligation to buy.

Of course, there’s also the possibility that tastes will change, demand for the artist’s work will dry up and prices will be driven down. The collector who paid $500 upfront for a painting can either sell it at a loss or hang the overpriced dust magnet above the sofa and hope that the world will someday deem it a masterpiece.

The collector who paid for the option contract also suffers a loss: There’s no financial upside to exercising his option, because the strike price in the contract is now higher than the cost of buying the painting on the open market. But at least his loss is limited to just what he paid for the contract.

Remember, at no point is someone who buys an option obligated to buy the underlying asset. They can simply walk away from the deal and have enough money left over to shop for something else to put on the living-room wall. Or, leaving the metaphor behind now, to add to their investment portfolio.

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: Email: dyochim@nerdwallet.com. Twitter: @DayanaYochim.

This post has been updated.

Options Trading 101

How to Trade Options

Investing, Investing Strategy, Investments

How to Trade Options

Investing, Investing Strategy, Investments
How to Trade Options

When you buy a stock, you decide how many shares you want, and your broker fills the order at the prevailing market price. The process is more complicated for options trading.

When you buy an option, you’re purchasing a contract to buy or sell a stock, usually 100 shares of the stock per contract, at a pre-negotiated price by a certain date. In order to place the trade, you must make three strategic choices:

  • Decide which direction you think the stock is going to move.
  • Predict how high or low the stock price will move from its current price.
  • Determine the time frame during which the stock is likely to move.
  1. Decide which direction you think the stock is going to move

This determines what type of options contract you’ll buy. If you think the price of a stock will rise, you’ll buy a call option. A call option is a contract that gives you the right, but not the obligation, to buy a stock at a predetermined price within a certain time period.

If you think the price of a stock will decline, you’ll buy a put option. A put option gives you the right, but not the obligation, to sell shares at a stated price before the contract expires.

  1. Predict how high or low the stock price will move from its current price

This is the strike price — the agreed-upon share price at which you would buy or sell the stock if you exercise the option. So, for example, if you believe the share price of a company that is currently trading for $100 is going to rise, you’d buy a call option with a strike price that is less than the $100 you’d pay for shares on the open market right now. If the price does indeed rise above the strike price, you make a profit. Similarly, if you believe the company’s share price is going to dip, you’d buy a put option (giving you the right to sell shares) at a strike price above $100. If the stock price drops, your contract has locked in your right to sell shares for more than they’re fetching on the open market.

You can’t just choose any strike price. Option quotes, technically called option chains, contain a range of available strike prices. The increments between strike prices are standardized across the industry — for example, $1, $2.50, $5, $10 — and are based on the stock price.

The difference between the strike price and the share price is part of what determines an option’s intrinsic value. Time is the other part of the valuation formula, which leads us to the final choice you need to make before buying an options contract.

  1. Determine the time frame during which the stock is likely to move

Every options contract has an expiration date that indicates the last day you can exercise the option. Here, too, you can’t just pull a date out of thin air. Your choices are limited to the ones offered when you call up an option chain.

Expiration dates can range from days to months to years. Daily and weekly options tend to be the riskiest and are reserved for seasoned option traders. For long-term investors, monthly and yearly expiration dates are preferable.

The amount of time (called time value) and the intrinsic value (the difference between the strike price and the open market price of the shares) determines the cost of the contract, known as the option premium.

Anatomy of an options trade: Call option example

Let’s go through one of the more basic options trading scenarios that an investor might use: buying a call option.

You believe that XYZ’s stock price is going to increase in the next month, and you want to lock in the option to buy shares at a lower price. You decide to buy a call option on XYZ with a strike price of $90 that expires in one month. The premium on that option is $3 per share. Here’s how much you’ll pay:

  • The per-share cost, or premium: Remember, each options contract typically contains 100 shares. So you’ll pay $300 (the $3 premium multiplied by 100 shares) for the right to buy 100 shares of XYZ stock at $90 per share before the expiration date.
  • Trading costs: Many brokers price options trades in two parts: a base rate (an option commission) and a per-contract fee. If your brokerage charges a $7.95 base rate and a 75 cent per-contract fee, you’ll pay $8.70 in commissions.

That brings your total tab for the call option on XYZ to $308.70.

» MORE: Options trading terms and definitions

The upside: What you can do if your prediction is correct

Let’s say you’re right, and XYZ’s stock price rises to $100. Your option is, in options-speak, “in the money.” For a call option, that means the share price on the open market is higher than the option’s strike price. (For a put option to be in the money, the share price must be lower than the strike price.)

Now you have another choice to make. You can:

  • Exercise the option and hold the shares. If you think the stock will continue to rise, you can exercise the option (buy the shares) and admire them in your portfolio. Your total cost to acquire the shares comes to $9,308.70. (The math: The $90 strike price multiplied by 100 shares, plus $308.70 for the original contract.) Right off the bat, you’ve gotten the equivalent of a 7.4% return compared with investors who waited to buy shares at $100. Note that partial trades are not allowed; options traders must exercise all 100 shares in a contract.
  • Exercise the option and sell the shares. In this scenario, you’d buy the shares at the $90 strike price for $9,000 and sell them right away at $100 per share, for $10,000. Factoring in the $308.70 trading costs, you would make $691.30 — a 124% return on the initial price of the contract.
  • Sell the options contract to another investor. If you don’t want to spend the money to buy the shares, you can always close out your position and sell the contract to another investor. If this is your plan from the outset, ideally the stock price moves shortly after you purchase the contract. The more time there is before the contract expires, the more the contract is worth. Let’s say the premium on your XYZ call increases to $12 from the $3 you originally paid. If you close out your position, you’ll pocket $891.30 ($1,200 as the recipient of the option premium minus the $308.70 you paid for the original contract).

The downside: What happens if your prediction is wrong

First, the good news: When you buy a put or call option, you are in no way obligated to follow through on the trade. If your assumptions about the time frame and direction of XYZ’s trajectory are incorrect — if the stock never rises above $90 or if it drops below your strike price — your losses are limited to a maximum of the $308.70 you paid for the contract and trading fees.

Had you been speculating and bought shares of XYZ on the open market before the price took a dive, your financial loss would cut a lot deeper.

The bad news, as you probably guessed: When your prediction doesn’t pan out during the time frame specified in your contract, the option expires worthless. Or, in the gentler terms of option traders, it’s out of the money.

However, if you’re a quick enough draw, you may be able to salvage a little of your initial investment. The option’s intrinsic value may have tanked, but you could limit your losses if you sell the contract before it expires, while it still has time value.

» MORE: Options trading strategies

Before you can start trading options …

If anything you’ve read so far gives you pause — the amount of capital required to trade options, the complexity of predicting multiple moving parts, the reliance on timing — that’s a good thing. That’s exactly what brokers require potential options investors to do before awarding a permission slip to start trading options.

Every brokerage firm screens potential options traders to determine their experience and understanding of the inherent risks of options trading and whether they’re financially prepared to handle them.

Account minimums and trading costs are important considerations for investors looking for the best brokerage firm to use. But even more important, especially for investors new to option trading, is finding a broker that offers the tools, research, guidance and support you need.

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: Email: dyochim@nerdwallet.com. Twitter: @DayanaYochim.

Updated Nov. 17, 2016.

Options Trading 101

Options Trading Terms and Definitions

Investing, Investing Strategy, Investments

Options Trading Terms and Definitions

Investing, Investing Strategy, Investments
options-trading-definitions

Contracts. Calls. Puts. Premium. Strike price. Intrinsic value. Time value. In, out of and at the money. This is the language of options traders — a jargon-riddled dialect of traditional Wall Street-speak.

Becoming conversant first requires learning a few key terms. Here are the essentials of options trading for beginning investors.

Options contract definitions

There are four key things to know on an options contract:

1. Option type: There are two types of options you can can buy or sell:

  • Call: An options contract that gives you the right to buy stock at a set price within a certain time period.
  • Put: An options contract that gives you the right to sell stock at a set price within a certain time period.

2. Expiration date: The date when the options contract becomes void. It’s the due date for you to do something with the contract, and it can be days, weeks, months or years in the future.

3. Strike price, or exercise price: The price at which you can buy or sell the stock if you choose to exercise the option.

4. Premium: The per-share price you pay for an option. The premium consists of:

  • Intrinsic value: The value of an option based on the difference between a stock’s current market price and the option’s strike price.
  • Time value: The value of an option based on the amount of time before the contract expires. Time is valuable to investors because of the possibility that an option’s intrinsic value will increase during the contract’s time frame. As the expiration date approaches, time value decreases. This is known as time decay or “theta,” after the options pricing model used to calculate it.

» MORE: Best brokers for options trading

Stock option quotes explained

Call up a stock quote and you get the current market share price of the company — the amount you’d pay if you bought shares or the amount you’d receive if you sold them. Quotes for options contracts are a lot more complex, because multiple versions are available to trade based on type, expiration date, strike price and more.

When you call up an options quote you’ll see a table of available options contracts, called option chains:

example-options-table

Each row in the table contains key information about the contract:

Strike: The price you’d pay or receive if you exercised the option.

Contract name: Just like stocks have ticker symbols, options contracts have option symbols with letters and numbers that correspond to the details in a contract. In a real option chain, the company’s ticker symbol would come before the contract name.

Last: The price that was paid or received the last time the option was traded.

Bid: The price a buyer is willing to pay for the option. If you’re selling an option, this is the premium you’d receive for the contract.

Ask: The price a seller is willing to accept for the option. If you want to buy an option, this is the premium you’d pay.

Change: The price change since the previous trading day’s close, also expressed in percentage terms.

Volume: The number of contracts traded that day.

Open interest: The number of options contracts currently in play.

Volatility: A measurement of how much a stock price swings between the high and low price each day. Historic volatility, as the name implies, is calculated using past price data. It can be measured on an annual basis or during a certain time frame.

Implied volatility, or “IV” in options-quote shorthand, measures how likely it is that the market thinks a stock will experience a price swing. (You also might hear of “vega,” the option pricing model used to measure the theoretical effect that each one-point change in the stock price has on implied volatility.)

Higher implied volatility typically means higher option prices because of higher potential upside for the contract. But don’t take these calculations as certainties. Just as earnings estimates are merely an analyst’s prediction of what a company is likely to earn, volatility measures are only predictions about how much an option’s price may change.

Terms to describe what an option is worth

When it comes to describing options performance, saying “up,” “down” or “flat” doesn’t cut it. At any given moment that an options contract is in play, it is one of three things:

In the money: This refers to an option that has intrinsic value — when the relationship between stock price in the open market and the strike price favors the options contract owner. When the stock price is higher than the strike price, that’s good news for the owner of a call option. A put option is in the money if the stock price is lower than the strike price.

Out of the money: When there’s no financial benefit to exercising the option, it’s called out of the money. Practically speaking, an out-of-the-money option makes buying or selling shares at the strike price less lucrative than buying or selling on the open market. A call option is out of the money if the stock price is lower than the strike price. A put option is out of the money when the stock price is higher than the strike price.

At the money: When the stock price is roughly equal to the strike price, an option is considered at the money. Basically, it’s a wash.

Options buyer and seller terms

These last two cover types of options traders. This is another case where traditional terms like “buyer” and “seller” don’t quite capture the nuances of options trading.

Holder: Refers to the investor who owns an options contract. A call holder pays for the option to buy the stock based on the parameters of the contract. A put holder has the right to sell the stock.

Writer: Refers to the investor who is selling the options contract. The writer receives the premium from the holder in exchange for the promise to buy or sell the specified shares at the strike price, if the holder exercises the option.

Besides being on opposite sides of the transaction, the biggest difference between options holders and options writers is their exposure to risk.

Remember, holders are purchasing the right to buy or sell shares, but they aren’t obligated to do anything. Their contract grants them the freedom to decide when — or if — to exercise the option, or to sell the contract before it expires. If they end up with an out-of-the-money option, they can walk away and let the contract expire. They lose only the amount they paid for the option (the premium) plus the cost of trade commissions.

Writers don’t have that flexibility. For example, when a call holder decides to exercise an option, the writer is obligated to fulfill the order and sell the stock at the strike price. If the writer doesn’t already own enough shares of the stock, he’ll have to buy shares at the going market price — even if it’s higher than the strike price — and sell them at a loss to the call holder.

Because of the unlimited downside potential, we recommend that investors just getting started in options stick to the buying (holding) side before venturing into more sophisticated options trading strategies.

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: Email: dyochim@nerdwallet.com. Twitter: @DayanaYochim.

Options Trading 101

3 Simple Options Trading Strategies

Investing, Investing Strategy, Investments

3 Simple Options Trading Strategies

Investing, Investing Strategy, Investments
Options Trading 101: 3 Simple Options Trading Strategies

Options investors can do a lot of things with puts and calls: buy them, sell them, buy and sell them at the same time, or get into options spreads of the bull and bear varieties.

Of course, when trading options the goal is to be on the winning side of the deal. But equally important is to limit potential losses. In that spirit, here are three options trading strategies that can help you walk that risk-reward balance beam successfully.

1. The covered call

For options traders, a covered call is equivalent to ordering a nightcap to top off a pleasant evening. It’s a strategy that long-term investors can use to lock in profits and try to eke out additional income on a stock they own.

How it works: A call option is a contract that allows you to buy a stock if it reaches a particular price. With a covered call, you’re selling that contract — also known as writing a call — to someone else. As the writer, you’re obligated to sell those shares if that buyer exercises the option. Since you already own the shares you’re offering to sell, the call is “covered.”

Let’s say you bought 100 shares of XYZ at $90, and now it’s trading at $99. You’re happy with the gain and had planned to sell the shares and take your profits when the price hit $100. Since the current price is close to your target sell price, you decide to write a covered call with a strike price of $100 that expires in one month. The investor who purchases the right to buy your shares pays you a $3 premium on that contract, which means you collect $300 upfront ($3 multiplied by 100 shares).

Potential upside: The ideal outcome of writing a covered call is that the stock price comes close to, but never exceeds, the option’s strike price — think $99.99. In that case, you make $300, minus the commission you paid on the contract, on the trade — and you keep your shares. You’re now free to write another call at the same or a different strike price, or simply sell the shares.

Potential downside: If XYZ shoots up to $105, you’re obligated to sell your shares at the $100 strike price stipulated in the contract, and the $500 gain belongs to the buyer. In this scenario you still get the $300 you made on the premium, but you leave $200 in gains on the table. In other words, your total upside is capped by the premium you received.

Why use it: A covered call is a relatively low-risk options trading strategy that’s appropriate for long-term investors whose gains on a stock are near their target sell price, especially if they’re looking to pare back the size of a position. It’s also a good tool to offset potential losses if the company is in danger of suffering some near-term volatility. It’s not a strategy you want to use if you think the company still has a lot of potential upside.

Good to know: Writing a call contract is risky if you don’t already own the shares. In fact, because of the potential liability, most brokerages require options traders to have a margin account if they want to sell calls. Remember, if the trade moves against you, you owe someone 100 shares. However, most options trading brokers will let beginner traders sell a covered call, because they’re agreeing to sell an asset they already own.

2. The married put

A married put works like a prenuptial contract on a stock you already own. If the share price of a stock you own drops unexpectedly, a married put gives you the right to sell your shares at a guaranteed price in order to cap your loss.

How it works: Buying a put is a strategy that options traders use to profit from a stock that is dropping in price. When you buy a married put, you’re buying a contract that allows you to sell shares of a stock you already own at a guaranteed price. It works like an insurance policy to protect you against big price declines.

Let’s say you bought 100 shares of XYZ on the open market for $100. You think the company has a lot of potential for growth, but you’re worried that in the next month the price may drop significantly if the company doesn’t report healthy earnings for the quarter. To hedge against a potential loss, you pay a $2-per-share premium to buy a put option at a strike price of $95 that expires in one month. Your total cost for the contract is $200.

Potential upside: Since married puts are a hedging strategy, success isn’t measured by how much money you make but rather by how little you lose. If XYZ holds steady or rises during the month, you make money on the underlying asset — the stock. However, your net gains will be diminished by the amount you paid for the premium. That’s the tradeoff for buying protection.

Potential downside: If XYZ shares drop below $95, your married put caps your loss at $700 ($5 per share in the contract, plus $2 per share for the option premium). But note that the protection is good only for the length of the contract. If XYZ shares plummet the day after the contract expires, you bear the full brunt of losses.

Why use it: Just like insurance for cars and homes, you buy a married put to protect yourself from potential investment losses. The premium is akin to the cost of the insurance policy.

Good to know: As the holder (buyer) of a put on a stock you already own, you’re under no obligation to break up and sell your shares if the stock price drops to the level of the strike price. If you think the stock is simply a victim of an overly reactive market or other short-term noise, you’re free to stick it out and hold onto your shares.

3. The long straddle

A long straddle is an options trading strategy that helps investors deal with FOMO — that is, the fear of missing out on the action. The action, in this instance, is volatility. If you think a stock is poised for a dramatic price swing, but you’re not sure which way it will swing, a long straddle covers both scenarios. It gives you unlimited upside potential while limiting potential losses.

How it works: A long straddle involves buying a call option and a put option on the same stock with the same strike price and expiration date. Let’s say XYZ is expected to make an important announcement during its next earnings call — that one of its major business ventures is on its way to being a triumphant success or epic disappointment. You pay a $200 premium to purchase a call option to buy shares at a $100 strike price and shell out another $200 premium on a put option to sell shares at $100.

Potential upside: With a long straddle, the goal is for the share price to move enough in either direction for the gains to more than offset what you paid on the contract premiums. So if XYZ takes off and rises to $110, your call option lets you buy shares at a 6% discount. You’ll pay $10,000 to buy shares that cost $11,000 on the open market, but since you paid $400 in premiums for the contracts, your total profit is $600.

The math is the same if XYZ drops to $90, since you have a put option that gives you the right to sell shares at $100. So, in summary, you make money as long as the share price moves up or down by enough; in this case, by $4 in either direction.

Potential downside: Sometimes big announcements come and go with little fanfare. As the buyer of a put or call, you’re not obligated to exercise either of your options. If the stock price doesn’t move enough in either direction to offset what you paid for the option contracts, it doesn’t make sense to exercise the option. And if the stock doesn’t move at all, both of your contracts expire with no value. Either way, your maximum downside with this trade is the amount of money you paid for the contracts.

Why use it: A long straddle lets you play both sides of a coin toss, essentially. As long as the share price moves a certain percentage up or down, the trade pays off. However, if you feel strongly that a stock will move one way or the other, you’re better off simply buying either a call or a put, not both.

Good to know: Option premiums are based on the what the market — aka other investors — predict will happen to a stock. The higher the premium, the more the market thinks the stock will move, on average, which means you need the stock to move even more in order to break even.

» MORE: Best brokers for options trading

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: Email: dyochim@nerdwallet.com. Twitter: @DayanaYochim.

Options Trading 101

5 Tips for Choosing an Options Broker

Brokers, Investing, Investments

5 Tips for Choosing an Options Broker

Brokers, Investing, Investments
5 Tips for Choosing an Options Broker

Options trading can be complicated. But if you choose your options broker with care, you’ll quickly master how to conduct research, place trades and track positions.

Here’s our advice on finding a broker that offers the service and the account features that best serve your options trading needs.

1. Look for a free education

If you’re new to options trading or want to expand your trading strategies, finding a broker that has resources for educating customers is a must. That education can come in many forms, including:

  • Online options trading courses.
  • Live or recorded webinars.
  • One-on-one guidance online or by phone
  • Face-to-face meetings with a larger broker that has branches across the country.

It’s a good idea to spend a while in student-driver mode and soak up as much education and advice as you can. Even better, if a broker offers a simulated version of its options trading platform, test-drive the process with a paper trading account before putting any real money on the line.

2. Put your broker’s customer service to the test

Reliable customer service should be a high priority, particularly for newer options traders. It’s also important for those who are switching brokers or conducting complex trades they may need help with.

Consider what kind of contact you prefer. Live online chat? Email? Phone support? Does the broker have a dedicated trading desk on call? What hours is it staffed? Is technical support available 24/7 or only weekdays? What about representatives who can answer questions about your account?

Even before you apply for an account, reach out and ask some questions to see if the answers and response time are satisfactory.

3. Make sure the trading platform is easy to use

Options trading platforms come in all shapes and sizes. They can be web- or software-based, desktop or online only, have separate platforms for basic and advanced trading, offer full or partial mobile functionality, or some combination of the above.

Visit a broker’s website and look for a guided tour of its platform and tools. Screenshots and video tutorials are nice, but trying out a broker’s simulated trading platform, if it has one, will give you the best sense of whether the broker is a good fit.

Some things to consider:

  • Is the platform design user-friendly or do you have to hunt and peck to find what you need?
  • How easy is it to place a trade?
  • Can the platform do the things you need, like creating alerts based on specific criteria or letting you fill out a trade ticket in advance to submit later?
  • Will you need mobile access to the full suite of services when you’re on the go, or will a pared-down version of the platform suffice?
  • How reliable is the website, and how speedily are orders executed? This is a high priority if your strategy involves quickly entering and exiting positions.
  • Does the broker charge a monthly or annual platform fee? If so, are there ways to get the fee waived, such as keeping a minimum account balance or conducting a certain number of trades during a specific period?

4. Assess the breadth, depth and cost of data and tools

Data and research are an options trader’s lifeblood. Some of the basics to look for:

  • A frequently updated quotes feed.
  • Basic charting to help pick your entry and exit points.
  • The ability to analyze a trade’s potential risks and rewards (maximum upside and maximum downside).
  • Screening tools.

Those venturing into more advanced trading strategies may need deeper analytical and trade modeling tools, such as customizable screeners; the ability to build, test, track and back-test trading strategies; and real-time market data from multiple providers.

Check to see if the fancy stuff costs extra. For example, most brokers provide free delayed quotes, lagging 20 minutes behind market data, but charge a fee for a real-time feed. Similarly, some pro-level tools may be available only to customers who meet monthly or quarterly trading activity or account balance minimums.

5. Don’t weigh the price of commissions too heavily

There’s a reason commission costs are lower on our list. Price isn’t everything, and it’s certainly not as important as the other items we’ve covered. But because commissions provide a convenient side-by-side comparison, they often are the first things people look at when picking an options broker.

A few things to know about how much brokers charge to trade options:

  • The two components of an options trading commission are the base rate — essentially the same as thing as the trading commission that investors pay when they buy a stock — and the per-contract fee. Commissions typically range from $3 to $9.99 per trade; contract fees run from 15 cents to $1.25 or more.
  • Some brokers bundle the trading commission and the per-contract fee into a single flat fee.
  • Some brokers also offer discounted commissions based on trading frequency, volume or average account balance. The definition of “high volume” or “active trader” varies by brokerage.

If you’re new to options trading or use the strategy only sparingly you’ll be well-served by choosing either a broker that offers a single flat rate to trade or one that charges a commission plus per-contract fee. If you’re a more active trader, you should review your trading cadence to see if a tiered pricing plan would save you money.

Of course, the less you pay in fees the more profit you keep. But let’s put things in perspective: Platform fees, data fees, inactivity fees and fill-in-the-blank fees can easily cancel out the savings you might get from going with a broker that charges a few bucks less for commissions.

There’s another potential problem if you base your decision solely on commissions. Discount brokers can charge rock-bottom prices because they provide only bare-bones platforms or tack on extra fees for data and tools. On the other hand, at some of the larger, more established brokers you’ll pay higher commissions, but in exchange you get free access to all the information you need to perform due diligence.

» MORE: NerdWallet’s top brokers for options trading

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: Email: dyochim@nerdwallet.com. Twitter: @DayanaYochim.