- Options trading allows investors to invest less money and earn higher returns compared to buying and selling stocks
- Many investing platforms are available, each with their own pros and cons
- Robinhood was the most popular trading platform, but many have soured on using them to trade options
Options trading became a more popular investing strategy recently after the meme stock craze a few years ago. Traders have found that they can invest with less money and potentially earn higher returns in options than if they bought and sold stocks.
Here is a brief rundown of options trading and some of the most popular trading platforms to trade options.
(Not keen on learning the ins and outs of options trading? Check out Q.ai’s Short-Squeeze Investment Kit for easy, no-hassle options-style trading. Download the app to try it for yourself.)
A brief overview of options trading
An option is a contract that gives the contract holder the option to buy or sell a security without the obligation of closing the deal. Essentially, the holder is betting on the asset increasing or decreasing in price, how much it moves up or down, and the time frame in which these shifts will happen.
Someone looking to enter into an options trading contract can buy or sell the contract itself before it expires, sell a contract to another buyer, or let the contract expire if the desired changes aren't happening.
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The holder buys the contract from a contract writer and pays a premium to the writer for the right to buy or sell the assets in the contract. If the holder doesn't execute the contract before it expires, they'll lose their initial investment but nothing more.
Options reflect the holder’s opinion about the future state of the security that's in the contract. The holder can buy a put option for a security they think will lose value or a call option when they believe a security is likely to increase in value. When either action happens, the holder can exercise their option to sell the securities at a strike price.
Options trading can be complex and is recommended for experienced investors because there's a risk of a financial loss if the option isn't exercised or if the security doesn't perform as expected.
How options trading became mainstream with meme stocks
Before the rise of meme stocks, options trading had the reputation of being an investment strategy beyond the average retail investor. That all changed when it became widely known that hedge funds were shorting the stocks of some retailers, believing these companies were headed towards bankruptcy in 2020 and 2021. Traders from all facets of the financial industry decided they were tired of the hedge funds making millions of dollars shorting the stock and wanted to do something about it.
This led to experienced and inexperienced traders buying options contracts, usually with the expectation that the stock would increase in price, and brought awareness of this trading tool to the general public. Anyone, including retail investors, can buy options contracts through trading platforms and engage in the same activity as institutional traders.
The main advantage in this scenario is to buy call options. Buying a call option allows the investor to start a position without putting up as much money. For example, to purchase 100 shares of a $10 stock, you would need $1,000. But buying one option contract on the same 100 shares of stock might only cost you $85.
Many more retail traders are getting involved in trading options as their investing strategy. The following is an overview of popular option trading platforms for retail investors.
Tastyworks is a low-cost options trading platform that's somewhat bare-bones in terms of its offerings. It's geared more towards experienced options traders, but its low cost of entry allows the amateur to buy a contract without risking a lot of money.
The pros of Tastyworks come from its focus on popular securities, $0 commissions and $1 per contract buy. The platform caps the commissions on each trade at $10 per leg.
Cons include the fact that it's lacking in educational resources, setting up an account is a slow process, and it doesn't offer a lot in the way of securities.
TD Ameritrade offers investors a mature platform that's backed by Charles Schwab. It has no minimum balance requirement and no commission fees, and it charges $0.65 per contract.
The pros of TD Ameritrade come in the depth and breadth of the types of securities you can buy for an options contract. It offers free research and educational materials that are easy to read and understand. The con is that the site may feel somewhat cumbersome to use relative to others.
Interactive Brokers offers a trading platform for advanced options traders looking for a wide variety of securities and assets to trade in. A trader can trade stocks, bonds, forex, futures, cryptocurrencies, funds and bonds from 150 markets from a single account. The brokerage also has a deep research library and offers resources that include reports, tools and calculators to help traders make decisions.
The pros of Interactive Brokers come from the site's ability to offer a range of investment assets, excellent order execution, a trading tool that meets just about every need, and a low commission and margin rate. The only con to the brokerage is that it can intimidate small-time investors who don't know where to start with options trading.
E*Trade is one of the earliest electronic trading platforms that revolutionized how retail investors accessed the stock market. This ethos is still in force today as the brokerage is focused on helping beginner traders understand the basics of options trading. Traders of all experience and income levels get access to proprietary research that's typically only available to those of high net worth. The site charges $0.65 per options contract and has watch lists considered among the best in the business.
E*Trade has a lot of pros, especially when it comes to making all types of trading easy and customizable to your needs. The cons to E*Trade are that the site doesn't offer cryptocurrencies, and its fees and margin rates are high in certain areas. Lastly, its web-based trading platform may not appeal to traders who want access to comprehensive tools.
Merrill Edge's trading platform is aimed at investors who want to control their investments but aren't looking to make fast trades and want to hold for the long term. It also has 2,800 retail locations and hundreds of financial advisors for its customers to access. It also offers customer perks, including preferred pricing for guided investing, lower interest rates on auto loans, and reduced mortgage origination fees.
Merrill Edge's pros include being part of Bank of America (BoA), an advantage for current customers of BoA. It offers in-depth research to aid its customers in their decision-making, and there are no fees or minimum charges for self-directed trading accounts. The cons come from a limited line of product offerings, and the platform is limited regarding available trading actions.
What about Robinhood?
In the early days of the meme stock craze, many options traders investing in Gamestop and AMC were doing so through Robinhood, a new investing startup. Investors were lured to this platform by its simplistic design and free stock trades. But all the excitement around the trading platform quickly diminished on Jan. 28, 2021 when Robinhood announced it was stopping investors from buying certain stocks. Investors could still sell shares, just not buy more.
The next day, Robinhood allowed investors to buy stock in certain companies on a limited basis, meaning they could only buy a certain number of shares. They could not purchase options or trade on margin.
Robinhood users were infuriated that traders on other platforms could still buy and sell stocks without restriction. The move to restrict meme stock purchases ended up hurting the company and eroding investors’ trust.
The bottom line
Trading options is a popular investment strategy, but it comes with many risks, especially for newer traders who are still learning how the market works. As a result, it is a financially smart move to learn how options work first before investing any money.
This doesn't mean you cannot invest in the stock market in the meantime. For example, one could invest in the Short Squeeze Kit from Q.ai. This kit uses artificial intelligence to spot trends and invest accordingly. By choosing this route, you can gain exposure to the stock market, and when you are more comfortable with options, you can begin trading those.
Download Q.ai today for access to AI-powered investment strategies.