Option trading works

Options Basics Tutorial.

Nowadays, many investors' portfolios include investments such as mutual funds, stocks and bonds. But the variety of securities you have at your disposal does not end there. Another type of security, known as options, presents a world of opportunity to sophisticated investors who understand both the practical uses and inherent risks associated with this asset class.

The power of options lies in their versatility, and their ability to interact with traditional assets such as individual stocks. They enable you to adapt or adjust your position according to many market situations that may arise. For example, options can be used as an effective hedge against a declining stock market to limit downside losses. Options can be put to use for speculative purposes or to be exceedingly conservative, as you want. Using options is therefore best described as part of a larger strategy of investing.

This functional versatility, however, does not come without its costs. Options are complex securities and can be extremely risky if used improperly. This is why, when trading options with a broker, you'll often come across a disclaimer like the following:

Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital.

Options belong to the larger group of securities known as derivatives. This word has come to be associated with excessive risk taking and having the ability crash economies. That perception, however, is broadly overblown. All “derivative” means is that its price is dependent on, or derived from the price of something else. Put this way, wine is a derivative of grapes; ketchup is a derivative of tomatoes. Options are derivatives of financial securities – their value depends on the price of some other asset. That is all derivative means, and there are many different types of securities that fall under the name derivatives, including futures, forwards, swaps (of which there are many types), and mortgage backed securities. In the 2008 crisis, it was mortgage backed securities and a particular type of swap that caused trouble. Options were largely blameless. (See also: 10 Options Strategies To Know .)

Properly knowing how options work, and how to use them appropriately can give you a real advantage in the market. If the speculative nature of options doesn't fit your style, no problem – you can use options without speculating. Even if you decide never to use options, however, it is important to understand how companies that you are investing in use them. Whether it is to hedge the risk of foreign-exchange transactions or to give employees ownership in the form of stock options, most multi-nationals today use options in some form or another.

This tutorial will introduce you to the fundamentals of options. Keep in mind that most options traders have many years of experience, so don't expect to be an expert immediately after reading this tutorial. If you aren't familiar with how the stock market works, you might want to check out the Stock Basics tutorial first.

How do Stock Options Work? Trade Calls and Puts – Part 1.

by Darwin on August 10, 2009.

Since I routinely post about stock options trading, investing, hedging and income generation and get the occasional question, “ How do Stock Options Work? ” or “ How to Trade Stock Options “, I figured I’d do a series on the various types of stock options strategies out there (they are numerous!) by starting with the most basic stock option strategies: Trading put and call options. I’ll start with some definitions and then get into some real-life examples.

Stock Option Trading Basics:

A Stock Options Contract is a contract between a buyer and a seller whereby a CALL buyer can buy a stock at a given price called the strike price and a PUT buyer can sell a stock at the strike price . 1 Stock Option contract represents 100 shares of the underlying stock Think of a CALL and a PUT as opposites. You can be a CALL Buyer OR Seller You can be a PUT Buyer OR Seller Given Puts/Calls and Buyer/Seller status, there are 4 main types of transactions we’ll cover today – Put Buyer, Put Seller, Call Buyer and Call Seller If you are an option buyer, you pay the listed “premium” for the option; conversely, as a seller of an option contract, you derive income equivalent to the “premium”

Key Options Terms are the following:

Strike Price: This is the key price that drives the transaction. For a Call option, if the underlying share price is BELOW the strike price, the option is “out of the money” and if so at expiry, it will expire worthless. For a Put option, if the underlying share price is ABOVE the strike price, the option is “out of the money” and if so at expiry, it will expire worthless. Expiration: This is the last date the option can be traded or exercised, after which it expires. Generally, there are options traded for each month and if they go out years, they are referred to as LEAPS. The same concepts hold for LEAPS as the stock options contracts we’re discussing here. Premium: This is just another word for the price of the option contract. Underlying Security: For our purposes, we will be discussing stock options. If you’re holding a contract on Microsoft, you have the right (but not the obligation) to exercise 100 shares of MSFT. Buyer or Seller Status: If you are the buyer, you have control of the transaction. You purchased the option contract and can execute the transaction or close it out or you can choose to allow the options contract to expire (usually only in the case where it is worthless). If you are a seller of an options contract, you are at the mercy of the buyer and must rely on the holder at the other end of the contract. There is the opportunity to “close out” the position.

Stock Options Trading Example #1 – Call Buyer:

People trade stock options for myriad reasons. Often times, it is purely for speculative reasons. For example, if you believe that the Swine Flu pandemic is going to become particularly troublesome and a stock with a vested interest in supplying vaccines in large quantities would stand to benefit from such a scenario, then perhaps you purchase an out of the money call option on Novavax. If shares are at $4.28 today and you think they could rocket past $10 on a massive epidemic, then perhaps you buy the January (expiry) 10 (strike) Call option. The cost (premium) is .70. The .70 is “per share” so .70*100=$70. This means it’s going to cost $70 to buy a single option contract, plus whatever trading commissions exist. Since you paid .7 or $70 and the strike price is $10 per share, by January expiry (the third Friday of every month), NVAX shares would need to be at $10.70 in order for you to break even. In order to have made money (in lieu of commissions), shares would need to exceed $10.70. If, for example, shares rocket to $20.00 at expiry and you sell the options back to close it out just prior to expiry, you’d pocket the difference between $20 and $10 and reap (10*100shares) = $1000. Given your initial $70 investment, even though shares only went up about 5-fold from $4.28 to $20, the option returned over 14-times the initial investment ($1000/$70). As you can see, utilizing these leveraged instruments can lead to big gains quickly. However, most options actually expire worthless – about 2/3 by most conventional estimates. There’s no free ride. For everyone looking for a speculative home run, there’s a seller on the other side deriving income from a speculative buyer thinking that the stock WILL NOT reach the strike price they sold at, so they’ll get to keep that .7 at the end of the expiry in January. Note that at the other end is a Call Seller which is often someone engaging in covered call option writing strategies – this can be a lucrative option strategy worth checking out as well.

Stock Option Trading Example #2 – Put Buyer:

When wondering if anyone actually made money during the economic collapse, the answer is a resounding YES! People who were holding puts on Financial and Real Estate stocks especially, made large returns on investment given the precipitous declines in shares of those companies. If for example, you feel we’re in for another economic calamity due to commercial mortgages collapsing next, and all Financials are going to fall, you could buy a Put option on the Financials ETF XLF, which is representative of the Financial sector at large. With a share price of $13.34, let’s say you buy a Dec09 expiry Put with a strike price of $10. That means that you expect the XLF ETF to drop well below $10 per share by December. The premium (or your cash outlay) for such a play is .25, or $25 per contract. That’s relatively cheap. But keep in mind that you’re talking about a 40% drop to just break even. If the XLF collapses and returns to its March lows of around $6 per share, your put would be worth about $4 at expriy (10-6). That represents a 16x return on investment. Imagine the players that had the foresight to buy out of the money puts in 2007 and 2008?

How to Trade Stock Options?

There are various online brokerage outfits that allow you to trade stock options. For most outfits, you can buy options without any special requirements. If you’re looking to sell options, because your risk is much greater (or unlimited for selling naked/uncovered calls), you generally need to sign up for a margin account and agree to risk notifications.

Here are the top online options trading brokerages based on reviews and costing:

1. optionsXpress – Awesome $100 Signup Bonus Running Now. Plus, $12.95 for 1,5, or 10 contracts – flat fee if hitting 35 traders/quarter. Otherwise $14.95/trade. A good price for newer/smaller options traders. Stocks are $9.95 per trade if greater than 8 trades per quarter or $14.95 for 8 or less trades.

2. Zecco – Another incredible pricing scenario –

Get 10 free stock trades every month with $25,000 balance or 25 trades each month $4.50 otherwise.

3. tradeMONSTER – $7.50 Stock Trades across the board. $12.50 Options Trades for up to 20 contracts.

4. OptionsHouse – An incredible $2.95 Stock Trading Price and $9.95 Options Contract Pricing.

5. Tradeking is widely knows as best in class for service and cost. I endorse TradeKing and I have an account myself. $4.95 stock trades and competitive on everything from Options to Margin. Check it out!

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I love TradeKing. I thought that I would never leave Etrade, but I was wrong. There is so much you can do and make with stock options. If you don’t use stock options currently then learn how to because you will make a killing with your little money that you have.

Richard Gulino Reply:

October 5th, 2011 at 2:52 pm.

Earn Cash Now, I am interested in learning about options and would be grateful for your teaching me..

Hi, I’m looking to invest in mobile app stocks and smartphone stocks. Can you provide any suggestions? So far I have SWKS, ARMH, MIMV, ZAGG, RFMD and NVDA from this list: wikinvest/wiki/Mobile_app_stocks but I need need additional positions. If there are any ETF’s with a focus on mobile that would be great too. Thanks – Phil Cantor.

Very useful. I think that options trading has great potential for the non-professional investor as well as the professionals. I think it is necessary to learn about some of the strategies beyond straight forward buying calls and puts. Is it realistic for the home trader to engage in selling options, or should he stick to buying only?

Than you so much for all of this great information. Your explanations on the ‘call buyer’ and ‘put’ buyer really helps. Another site that I have found to be very helpful for beginners is (optionsimple). Thanks again. You have helped me very much 🙂

Where can I find out the prices for put options? I would like to find out how much a put option cost if I had a strike price of the same amount that I bought a stock for and only need it for a short time say 5 days. I want to use it as insurance or protection that my stock doesn’t go below what I bought it for.

Binary Options are a Scam to take your money. They are offshore and unregulated by the US. Don’t be fooled if you go to youtube also search for binary options scam. You can give them your money they will take it you can make $50,000 but they will never send you a dime. Also if you give them your personal info. Instant Identity Theft.

Good explanation. I always find options to be more complex than stocks but this is a good start.

Options Basics: How Options Work.

Options contracts are essentially the price probabilities of future events. The more likely something is to occur, the more expensive an option would be that profits from that event. This is the key to understanding the relative value of options.

Let’s take as a generic example a call option on International Business Machines Corp. (IBM) with a strike price of $200; IBM is currently trading at $175 and expires in 3 months. Remember, the call option gives you the right , but not the obligation , to purchase shares of IBM at $200 at any point in the next 3 months. If the price of IBM rises above $200, then you “win.” It doesn’t matter that we don’t know the price of this option for the moment – what we can say for sure, though, is that the same option that expires not in 3 months but in 1 month will cost less because the chances of anything occurring within a shorter interval is smaller. Likewise, the same option that expires in a year will cost more. This is also why options experience time decay: the same option will be worth less tomorrow than today if the price of the stock doesn’t move.

Returning to our 3-month expiration, another factor that will increase the likelihood that you’ll “win” is if the price of IBM stock rises closer to $200 – the closer the price of the stock to the strike, the more likely the event will happen. Thus, as the price of the underlying asset rises, the price of the call option premium will also rise. Alternatively, as the price goes down – and the gap between the strike price and the underlying asset prices widens – the option will cost less. Along a similar line, if the price of IBM stock stays at $175, the call with a $190 strike price will be worth more than the $200 strike call – since, again, the chances of the $190 event happening is greater than $200.

There is one other factor that can increase the odds that the event we want to happen will occur – if the volatility of the underlying asset increases. Something that has greater price swings – both up and down – will increase the chances of an event happening. Therefore, the greater the volatility, the greater the price of the option. Options trading and volatility are intrinsically linked to each other in this way.

With this in mind, let’s consider a hypothetical example. Let's say that on May 1, the stock price of Cory's Tequila Co. (CTQ) is $67 and the premium (cost) is $3.15 for a July 70 Call, which indicates that the expiration is the third Friday of July and the strike price is $70. The total price of the contract is $3.15 x 100 = $315. In reality, you'd also have to take commissions into account, but we'll ignore them for this example. On most U. S. exchanges, a stock option contract is the option to buy or sell 100 shares; that's why you must multiply the contract by 100 to get the total price. The strike price of $70 means that the stock price must rise above $70 before the call option is worth anything; furthermore, because the contract is $3.15 per share, the break-even price would be $73.15.

Three weeks later the stock price is $78. The options contract has increased along with the stock price and is now worth $8.25 x 100 = $825. Subtract what you paid for the contract, and your profit is ($8.25 - $3.15) x 100 = $510. You almost doubled our money in just three weeks! You could sell your options, which is called "closing your position," and take your profits – unless, of course, you think the stock price will continue to rise. For the sake of this example, let's say we let it ride.

By the expiration date, the price of CTQ drops down to $62. Because this is less than our $70 strike price and there is no time left, the option contract is worthless. We are now down by the original premium cost of $315.

To recap, here is what happened to our option investment:

So far we've talked about options as the right to buy or sell (exercise) the underlying good. This is true, but in reality, a majority of options are not actually exercised. In our example, you could make money by exercising at $70 and then selling the stock back in the market at $78 for a profit of $8 a share. You could also keep the stock, knowing you were able to buy it at a discount to the present value. However, the majority of the time holders choose to take their profits by trading out (closing out) their position. This means that holders sell their options in the market, and writers buy their positions back to close. According to the CBOE​, only about 10% of options are exercised, 60% are traded (closed) out, and 30% expire worthless.

At this point it is worth explaining more about the pricing of options. In our example the premium (price) of the option went from $3.15 to $8.25. These fluctuations can be explained by intrinsic value and extrinsic value, also known as time value. An option's premium is the combination of its intrinsic value and its time value. Intrinsic value is the amount in-the-money, which, for a call option, means that the price of the stock equals the strike price. Time value represents the possibility of the option increasing in value. Refer back to the beginning of this section of the turorial: the more likely an event is to occur, the more expensive the option. This is the extrinsic, or time value. So, the price of the option in our example can be thought of as the following:

In real life options almost always trade at some level above their intrinsic value, because the probability of an event occurring is never absolutely zero, even if it is highly unlikely. If you are wondering, we just picked the numbers for this example out of the air to demonstrate how options work.

A brief word on options pricing. As we’ve seen, the relative price of an option has to do with the chances that an event will happen. But in order to put an absolute price on an option, a pricing model must be used. The most well-known model is the Black-Scholes-Merton​ model, which was derived in the 1970’s, and for which the Nobel prize in economics was awarded. Since then other models have emerged such as binomial and trinomial tree models, which are also commonly used.

Introduction to Options Trading.

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 to get started.

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 as 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 main advantages are:

Buying an option requires a smaller initial outlay than buying the stock. An option buys an investor time to see how things play out. An option protects investors from downside risk by locking in the price without the obligation to buy.

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.

You also can limit your exposure to risk on stock positions you already have. 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 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.

How to start trading options.

In order to trade options, you’ll need a broker. Check out our detailed roundup of the best brokers for options traders, so you can compare commission costs, minimums, and more. Or stay here and answer a few questions to get a personalized recommendation on the best broker for your needs.

More about options and trading.

Here are some more of our articles on the ins and outs of trading options:

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: : dyochimnerdwallet. Twitter: DayanaYochim.

This post has been updated.

Options Trading 101.

Options Trading 101.

How to Trade Options.

How to Trade Options.

Options trading can be complex, even more so than stock trading. When you buy a stock, you decide how many shares you want, and your broker fills the order at the prevailing market price or at a limit price. Trading options not only requires some of these elements, but also many others, including a more extensive process for opening an account.

Indeed, before you can even get started you have to clear a few hurdles. Because of the amount of capital required and the complexity of predicting multiple moving parts, brokers need to know a bit more about a potential investor before awarding them a permission slip to start trading options.

Opening an options trading account.

Brokerage firms screen potential options traders to assess their trading experience, their understanding of the risks in options and their financial preparedness.

Before you can start trading options, a broker will determine which trading level to assign to you.

You’ll need to provide a prospective broker:

Investment objectives such as income, growth, capital preservation or speculation Trading experience, including your knowledge of investing, how long you’ve been trading stocks or options, how many trades you make per year and the size of your trades Personal financial information, including liquid net worth (or investments easily sold for cash), annual income, total net worth and employment information The types of options you want to trade.

Based on your answers, the broker assigns you an initial trading level (typically 1 to 4, though a fifth level is becoming more common) that is your key to placing certain types of options trades.

Screening should go both ways. The broker you choose to trade options with is your most important investing partner. Finding the broker that offers the tools, research, guidance and support you need is especially important for investors who are new to options trading.

For more information on the best options brokers, read our detailed roundup to compares costs, minimums and other features. Or answer a few questions and get a recommendation of which ones are best for you.

Consider the core elements in an options trade.

When you take out 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 take on. 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 (called the strike 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.

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

An option remains valuable only if the stock price closes the option’s expiration period “in the money.” That means either above or below the strike price. (For call options, it’s above the strike; for puts it’s below the strike.) You’ll want to buy an option with a strike price that reflects where you predict the stock will be during the option’s lifetime.

For example, if you believe the share price of a company currently trading for $100 is going to rise to $120 by some future date, you’d buy a call option with a strike price less than $120 (ideally a strike price no higher than $120 minus the cost of the option, so that the option remains profitable at $120). If the stock does indeed rise above the strike price, your option is in the money.

Similarly, if you believe the company’s share price is going to dip to $80, you’d buy a put option (giving you the right to sell shares) with a strike price above $80 (ideally a strike price no lower than $80 minus the cost of the option, so that the option remains profitable at $80). If the stock drops below the strike price, your option is in the money.

You can’t choose just 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 price you pay for an option has two components: intrinsic value and time value.

The price you pay for an option, called the premium, has two components: intrinsic value and time value. Intrinsic value is the difference between the strike price and the share price, if the stock price is above the strike. Time value is whatever is left, and factors in how volatile the stock is, the time to expiration and interest rates, among other elements. For example, suppose you have a $100 call option while the stock costs $110. Let’s assume the option’s premium is $15. The intrinsic value is $10 ($110 minus $100), while time value is $5.

This leads us to the final choice you need to make before buying an options contract.

3. 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. Longer expirations give the stock more time to move and time for your investment thesis to play out.

A longer expiration is also useful because the option can retain time value, even if the stock trades below the strike price. An option’s time value decays as expiration approaches, and options buyers don’t want to watch their purchased options decline in value, potentially expiring worthless if the stock finishes below the strike price. If a trade has gone against them, they can usually still sell any time value remaining on the option — and this is more likely if the option contract is longer.

More about the types of options trades.

What's next?

Find the best broker for options traders.

Dig into options trading strategies.

Learn the essential options trading terms.

James F. Royal, Ph. D., and Dayana Yochim are staff writers at NerdWallet, a personal finance website. : jroyalnerdwallet, dyochimnerdwallet. Twitter: JimRoyalPhD, DayanaYochim.

This post has been updated.

Options Trading 101.

Options Trading 101.

5 Tips for Choosing an Options Broker.

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? ? 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.

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: : dyochimnerdwallet. Twitter: DayanaYochim.

Options Trading 101.

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