Options Trading: How to Trade Stock Options in 5 Steps

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Learning how to buy options comes down to five steps:

1. Check that you understand the product and can afford to lose the premium.
2. Open a brokerage account and get approved for options trading.
3. Build a plan that says what you will buy, when you will enter and when you will exit.
4. Learn how the trades are taxed.
5. Manage each position until you close it, exercise it or let it expire.

The mechanics are simple. You pay a premium, and in return you get the right, but not the obligation, to buy (a call) or sell (a put) 100 shares of a stock at a fixed strike price until a set expiration date. The hard part is the judgment behind each order: which strike, which expiration, how much to spend, and what to do if the stock moves slowly or not at all.

Options give you leverage. You can control the price exposure of 100 shares for a fraction of their cost, and your loss on a bought option is limited to the premium. That same structure lets a correct forecast pay several times what owning the stock would. It also means a forecast that is right but too slow can still lose the whole premium.

Options Basics You Need Before Step 1

Call option. The right to buy the underlying at the strike price before or at expiration. Calls gain value when the underlying rises.

Put option. The right to sell the underlying at the strike price. Puts gain value when the underlying falls.

Strike (exercise) price. The fixed price at which the contract lets you buy or sell.

Premium. The price of the option, quoted per share. Multiply by 100 for a standard equity contract.

Expiration date. The last day the contract exists. Standard monthly U.S. equity options expire on the third Friday of the month. Many stocks and ETFs also list weekly expirations.

Moneyness. This term describes where the strike sits relative to the current price:

• A call is in the money (ITM) when the stock trades above the strike.
• A put is in the money when the stock trades below the strike.
• An option is at the money (ATM) when the strike is at or near the stock price.
• An option is out of the money (OTM) when exercising it would make no sense today.

Intrinsic value and time value. A premium has two parts:

• Intrinsic value is what the option would be worth if exercised now. For a call, that is the stock price minus the strike, or zero if the result is negative.
• Time value (extrinsic value) is everything above intrinsic value. It reflects the chance of a favorable move before expiration and shrinks toward zero as expiration approaches.

Exercise style. American-style options can be exercised on any business day before expiration, and most U.S. equity options are American-style. European-style options can be exercised only at expiration, which applies to many cash-settled index options.

Listed U.S. options clear through the Options Clearing Corporation. The OCC stands between buyers and sellers, so your contract is not a private bet with whoever sold it to you.

Step 1: Assess Your Readiness

Options trading is more complex than buying shares, and it can be riskier. A stock you buy can sit through a bad quarter and recover. An option you buy has a deadline. To trade it well, you need to read price charts and data, understand how volatility feeds into premiums, and accept that a position can go to zero even when the company is doing fine.

Before funding an account, answer three questions honestly:

• How much can you lose without changing your plans? Treat every premium as money that may not come back. If losing it would hurt your rent, debt payments or emergency fund, it is too much.
• What are you trying to do? Speculating on direction, earning income on shares you own and insuring a portfolio point to different strategies and different approval levels.
• How much time can you give it? A bought option’s value changes with the stock price, the passage of time and implied volatility, so a position you check once a month behaves differently from one you review daily.

Step 2: Choose a Broker and Get Approved

You need a brokerage account that supports options. Compare brokers on:

• the per-contract fees they charge
• how clearly their platform shows the option chain and the risk of a position
• the quality of customer support when an expiration or assignment question comes up
• whether they offer education and paper trading

Options are not added to an account automatically. As part of setup, brokers ask you to complete an options application covering:

• your income, net worth and liquid assets
• your investment objectives (income, growth, speculation, hedging)
• your experience, typically in years and number of trades in stocks and options
• your employment status

Before you trade, the broker must also deliver the Options Disclosure Document, Characteristics and Risks of Standardized Options. It is worth reading the sections on exercise, assignment and the risks of writing options. Based on your answers, the broker assigns an approval level, which determines which order types you can enter.

Options Approval Levels

Each broker defines its own tiers. Some use four levels, some use five, and the strategies in each can differ. A common four-level structure looks like this:

Buying calls and puts outright usually requires Level 2 approval, the level this guide focuses on. If an order triggers a message about options restrictions, it most likely needs a higher level than your account has. Brokers let you request an upgrade, and they re-check your finances and experience when you do.

What the Account Costs

Many brokers charge no commission on stock and ETF trades, but options usually carry a charge, most often per contract. Some brokers add a flat per-trade fee on top. Here is an example, not any broker’s actual pricing: a $4.95 base fee plus $0.50 per contract would make a 10-contract order cost $4.95 + (10 × $0.50) = $9.95.

That figure applies to one side of the trade. If you open and then close the position, you pay it twice, so the round trip in this example is $19.90. Exchange and regulatory fees may also apply.

On a cheap OTM option, fees can be a meaningful share of the premium and raise your breakeven price.

Step 3: Build a Trading Plan

A trading plan turns a market view into specific orders. It should state:

• The setup: what has to be true about the stock, the chart or the calendar (for example, an upcoming earnings report) before you trade.
• The strategy: long call, long put, covered call, protective put or something else, and why it fits the view.
• Strike and expiration rules: how far in or out of the money you buy, and how much time you buy. More time costs more premium but gives the stock longer to move.
• Position size: the maximum premium you will risk on one trade, as a dollar amount or a share of the account.
• Exits: a profit target, a loss level at which you sell, and a time stop (for example, close by a set number of days before expiration if the move has not happened).

Test the plan before using real money. Paper trading lets you place simulated orders against market prices and see how premiums change from day to day. Our stock market simulator offers free paper trading.

Read the Option Chain

The option chain is the table of every listed contract for an underlying. You usually pick an expiration date first, and then you see calls and puts at each strike. For every contract the chain typically shows:

• Bid and ask. The bid is what buyers are offering and the ask is what sellers want. If a call shows a $3.90 bid and a $4.10 ask, the $0.20 spread is $20 per contract. Buying at the ask and selling at the bid costs you that spread on top of fees.
• Last price. The most recent trade. On thinly traded contracts this can be hours old and far from the current bid and ask.
• Volume. The number of contracts traded that day.
• Open interest (OI). The number of contracts that exist and have not yet been closed, exercised or expired. Strikes with little open interest and little volume can have wide bid-ask spreads, which makes entering and exiting more expensive.
• Implied volatility (IV). The volatility level implied by the option’s price. Higher IV means a higher premium for the same strike and expiration.
• Greeks. Sensitivity measures such as delta and theta, explained in Step 5.

Place the Order

Buying an option takes the same few fields at almost every broker:

1. Enter the underlying symbol and open its option chain.
2. Choose the expiration date.
3. Choose the strike and select call or put.
4. Select Buy to Open. This creates a new long position. You will later use Sell to Close to exit.
5. Enter the number of contracts.
6. Choose the order type. A limit order at or between the bid and ask lets you control the price you pay. A market order on a wide-spread contract can fill well above the midpoint.
7. Review the order ticket: total premium, fees and maximum loss. Then submit.

Brokers generally require you to pay the full premium in cash. Under Federal Reserve margin rules, options with nine months or less until expiration cannot be bought on margin. Longer-dated contracts can be partly margined at some brokers.

Where Options Trade (and When)

Listed U.S. options trade electronically on exchanges such as the Chicago Board Options Exchange (Cboe), and your broker routes your order to an exchange with the aim of best execution.

Regular trading hours for U.S. equity options run from 9:30 a.m. to 4:00 p.m. Eastern time, matching the stock market. Some index options have additional sessions. Brokers also set their own cutoff times for exercise instructions on expiration day, so check your broker’s deadline before you rely on exercising at the last minute.

Step 4: Understand the Tax Treatment

The IRS treats option transactions differently depending on what happens to the contract. IRS Publication 550 covers the rules for U.S. taxpayers. A few long-standing principles shape how most option buyers are taxed:

• You sell the option before expiration. The gain or loss is a capital gain or loss. Whether it is short-term or long-term depends on how long you held the option. Most equity options are held for less than a year, so gains are typically short-term and taxed at ordinary income rates.
• The option expires worthless. It is treated as sold on the expiration date for zero, giving you a capital loss equal to the premium paid.
• You exercise a call. The premium is added to the cost basis of the shares you buy, and the holding period for the shares starts the day after exercise.
• You exercise a put. The premium reduces the amount realized on the sale of the shares.
• You write a covered call. The premium you receive is generally not taxed until the call expires, is closed or is assigned. If assigned, the premium is added to the sale proceeds of the shares.
• Broad-based index options. Options on broad indexes can qualify as Section 1256 contracts. These are marked to market at year end and taxed 60% long-term and 40% short-term regardless of holding period.
• Wash sales. Wash sale rules can apply when you sell stock at a loss and buy a call on the same stock within 30 days, deferring the loss.

Tax outcomes depend on your full situation, strategy and jurisdiction. A tax professional can confirm how a specific trade will be treated.

Step 5: Manage the Position and Keep Learning

Once you own an option, you have three ways out, and each one should be part of the plan before you buy.

Close, Exercise or Let Expire

Sell to close. You sell the contract back into the market at the current bid. This is how many option buyers exit, because selling captures both intrinsic value and any remaining time value. Exercising captures only intrinsic value.

Exercise. You use the right in the contract. A long call exercised means you buy 100 shares at the strike, so you need the cash (or margin) to pay for them. A long put exercised means you sell 100 shares at the strike. Without the shares in your account, that creates a short stock position.

Let it expire. If the option is out of the money at expiration, it expires worthless and you lose the premium. If it is in the money by $0.01 or more, the OCC’s exercise-by-exception procedure generally exercises it automatically unless you instruct otherwise. That can leave you with an unexpected stock position. For example, an automatically exercised call on 100 shares of a $150 stock requires $15,000 you may not have in the account. Brokers may close such positions themselves near expiration to manage the risk, which is another reason to decide in advance.

The Greeks That Move Your Premium

An option’s price changes for reasons beyond the stock’s direction. The Greeks measure those sensitivities:

• Delta. How much the option price changes for a $1 move in the underlying. A call with a delta of 0.50 gains about $0.50 per share ($50 per contract) if the stock rises $1, all else equal. Puts have negative deltas.
• Theta. How much value the option loses per day from the passage of time. Theta works against buyers, and time decay generally speeds up as expiration nears.
• Vega. How much the price changes for a one-point change in implied volatility. Premiums often rise before scheduled events such as earnings, and implied volatility can drop sharply once the news is out. That drop can cut an option’s value even when the stock moves in the buyer’s direction.
• Gamma. How quickly delta itself changes as the stock moves. It is highest for at-the-money options close to expiration.

Risk management for option buyers rests on a few habits:

• Keep each premium small relative to the account.
• Avoid buying contracts with wide spreads and low open interest.
• Pick expirations that leave room for your thesis to play out.
• Follow your exit rules rather than hoping an out-of-the-money option recovers in its final days.

Buying Calls (Long Calls)

A long call is the most direct way to bet on a rising price. You buy a call and pay the premium. If the stock climbs above the strike plus the premium by expiration, the position is profitable. If the stock falls, your loss stops at what you paid.

Example

The figures below are hypothetical and chosen to show the mechanics. Fees are ignored.

Stock XYZ trades at $100, and a trader has $5,000 to put to work for about a month.

• Buying shares: $5,000 buys 50 shares. If XYZ rises 10% to $110, the shares are worth $5,500, a $500 gain or 10%.
• Buying calls: A one-month call with a $100 strike costs $4.00 per share, or $400 per contract. The trader buys 12 contracts for $4,800, which controls 1,200 shares. If XYZ is at $110 at expiration, each call has $10 of intrinsic value, so the 12 contracts are worth $10 × 100 × 12 = $12,000. The net gain is $12,000 − $4,800 = $7,200, a 150% return on the premium.

Now change one assumption. If XYZ finishes the month exactly at $100, the shareholder is flat, but the calls expire worthless and the trader loses the full $4,800. If XYZ finishes at $103, the shareholder is up $150, while each call is worth $3.00 against $4.00 paid: a $1.00 loss per share, or $1,200 across the position.

Risk and Reward

• Maximum loss: the premium paid ($400 per contract here).
• Breakeven at expiration: strike + premium = $100 + $4.00 = $104.
• Maximum gain: theoretically unlimited, because there is no ceiling on how high the stock can go before expiration.

Buying Puts (Long Puts)

A put works in the opposite direction from a call: it gains value as the stock falls. Short selling also profits from a decline, but a short seller’s loss is theoretically unlimited, because there is no limit to how high a stock can rise. If the stock ends above the strike, the put simply expires worthless.

Example

Again, the figures are hypothetical and fees are ignored.

A trader expects XYZ, now at $60, to fall after its next earnings report but does not want the open-ended risk of shorting it. The trader buys one $55 put for $1.50, or $150.

• If XYZ stays above $55 through expiration, the put expires worthless. The loss is $150.
• If XYZ drops to $48, the put has $7.00 of intrinsic value ($55 − $48). After the $1.50 premium, the profit is $5.50 per share, or $550 on one contract.

Risk and Reward

• Maximum loss: the premium ($150).
• Breakeven at expiration: strike − premium = $55 − $1.50 = $53.50.
• Maximum gain: large but capped, because a stock cannot fall below zero. The most this put could be worth is $55 per share, less the premium.

Covered Calls

A covered call is layered on shares you already own. You sell (write) one call for every 100 shares and collect the premium. In exchange, you agree to sell the shares at the strike if the option is exercised. The premium adds income and offers a small cushion against a decline, but it caps the upside of the stock.

This position suits traders who:

• expect the stock to stay flat or rise modestly, so they keep the full premium
• are willing to give up gains above the strike in return for that income

Example

These figures are hypothetical. A trader owns 100 shares of XYZ bought at $50 and sells one one-month call with a $55 strike for $1.00 per share, collecting $100.

• The premium lowers the effective cost basis to $49. A decline in the stock down to $49 is offset by the premium.
• If XYZ is above $55 at or before expiration, the call may be assigned and the shares called away at $55. The trader’s profit is $55 − $49 = $6.00 per share, or $600, no matter how high the stock went.
• If XYZ stays below $55, the call expires worthless. The trader keeps the $100 and the shares, and can write another call for the next expiration.

Because most equity options are American-style, assignment can happen before expiration. It is more likely when the call is deep in the money or just before an ex-dividend date.

Risk and Reward

The upside is capped at the strike plus the premium. The downside protection equals only the premium received: if XYZ fell to $40, the trader would still lose $9.00 per share ($49 − $40). The real cost of a covered call is the gain you give up if the stock rallies hard past the strike.

Protective Puts

A protective put is a long put bought against shares you already own. It sets a floor under the position for the life of the option. The price of that floor is the premium, so it works like insurance. A trader who is bullish over the long run but worried about a short-term decline can hold the shares and still cap the loss.

Example

These figures are hypothetical. An investor owns 100 shares of XYZ bought at $80 and wants protection for about two months. Choosing a strike below the current price lowers the premium but widens the uncovered loss, much like choosing a higher insurance deductible.

Buying the $80 put limits the worst case to the $300 premium, however far the stock falls. The $70 put costs only $50 but leaves the first $10 of decline unprotected.

Risk and Reward

If the stock stays flat or rises, the most you lose is the premium. If it falls, the maximum loss is (purchase price − strike) + premium, as the last column shows. The upside on the shares stays open, minus the cost of the put. Repeatedly buying protection every expiration adds up, so the premium should be weighed against the risk you are insuring.

Long Straddles

A long straddle means buying a call and a put on the same underlying with the same strike and the same expiration, usually at the money. It profits from a large move in either direction. That makes it a way to trade an expected burst of volatility, such as an earnings report, without picking a direction. Because you buy two at-the-money options, it costs more than buying either one alone.

Example

These figures are hypothetical. XYZ trades at $100 ahead of earnings. A trader buys a $100 call for $4.00 and a $100 put for $4.00, both expiring two weeks after the report. The total cost is $8.00 per share, or $800.

• The position profits at expiration if XYZ is above $108 (strike + total premium) or below $92 (strike − total premium).
• At $115, the call is worth $15 and the put is worthless, for a $7.00 per share profit.
• At exactly $100, both expire worthless and the full $800 is lost.

Risk and Reward

The maximum loss is the total premium. The upside gain is theoretically unlimited. The downside gain is capped because the stock cannot go below zero: here the put could be worth at most $100 per share, less the $8.00 total premium. Implied volatility often rises into scheduled events and can collapse after the news, so the stock has to move by more than the market expected for the trade to pay.

Other Options Strategies

These combinations reuse the same parts and become useful once the strategies above are familiar. Several require a higher approval level.

Married Put

A married put is a protective put bought at the same time as the shares, typically at the money, with one put per 100 shares. Because the stock’s loss is capped at the premium while its upside stays open, the combined payoff resembles a long call. For this reason it is sometimes called a synthetic call.

Protective Collar

A collar adds a short call to a protective put. You own the shares, buy an OTM put below the market and sell an OTM call above it, often with similar premiums so the hedge costs little.

Hypothetical example: shares bought at $80, a $75 put bought for $1.20 and a $90 call sold for $1.00, for a net cost of $0.20.

• The worst case at expiration is a loss of $5.20 per share ($80 − $75 + $0.20).
• The best case is a gain of $9.80 ($90 − $80 − $0.20).

Long Strangle

A strangle is like a straddle, but the strikes differ. You buy an OTM call and an OTM put with the same expiration, with the put strike below the call strike. It costs less than a straddle, but the stock must move further before it pays.

Hypothetical example: with XYZ at $100, a $105 call for $2.00 and a $95 put for $2.00 cost $4.00 in total. The breakevens at expiration are $109 and $91.

Vertical Spreads

A vertical spread buys one option and sells another of the same type (both calls or both puts) with the same expiration but different strikes. Bull spreads profit when the price rises, and bear spreads when it falls. The premium from the sold option lowers the cost, but it also caps the profit at the distance between the strikes.

Hypothetical bull call spread: buy a $100 call for $4.00 and sell a $110 call for $1.20, for a net debit of $2.80.

• Maximum loss: $2.80.
• Maximum profit: $7.20 ($10 between strikes − $2.80).
• Breakeven: $102.80.

Compared with the plain long call earlier, the spread costs less and breaks even sooner, but it stops gaining above $110.

Options vs. Stocks: Which Fits Your Goals

Neither is better in general. Stocks suit long holding periods: there is no expiration, dividends accrue to the owner, and a temporary drop can be waited out. Options suit specific jobs:

• leveraging a short-term directional view
• defining the maximum loss in advance
• hedging existing holdings
• generating income from shares through covered calls

Whether options fit you depends on your goals, risk tolerance, knowledge, finances, available time and discipline. A practical route:

1. Study the mechanics.
2. Paper trade until your simulated results reflect your plan rather than luck.
3. Start with small long calls, long puts or covered calls before moving to spreads.

FAQs

The Bottom Line

Anyone considering buying calls or puts should treat each premium as money that may not come back, since a correct forecast that moves too slowly can still lose it all. Start with Level 2 approval, a written plan with strike, size and exit rules, and limit orders on liquid contracts. Paper trade until results reflect the plan, then begin with small long calls, long puts or covered calls before trying spreads.