Options 101: 7 Terms You Must Know to Be a Successful Options Trader
Are you ready to take your options trading to the next level?
If so, it’s crucial that you understand the different types of orders you can use with your online broker.
Depending on your goals — and the strategy you employ to get there — you may find it helpful to use different types of orders. First, we’ll briefly review the basics of what it means to be “long” vs. “short,” which may affect the type of order you want to use…
Long vs. Short Positions
Long positions are taken when you own a stock, ETF, mutual fund, or option and hope to sell it at a later date for more than what you paid. In options trading, you are long when you buy a call or sell a put as your “opening” trade.
Short positions are held when you sell a security you don’t own. You will borrow the security that you short from your broker and buy the security later so that you can repay the loan. If the price falls while you are short, you profit.
In options trading, you are short when you sell (or write) a call or buy a put. There is no need to borrow shares when writing options, which makes options less expensive than short positions in the stock market. Here is a table to help you understand the difference between long and short positions with respect to call and put options…
With that out of the way, here are some terms you will need to know to execute your orders effectively…
7 Terms You Need To Know
Buy to open creates a long options position. If you think the price of a security will rise, for example, you can buy a call with a “buy to open” order. Alternatively, if you think prices will fall, you can buy a put with a “buy to open” order.
Sell to open is used when writing an option. Whether you write a put or call option, the trade will be initiated with a “sell to open” order. Confirming you are “selling to open” when placing your order is important. Some brokerage websites will automatically default to “buy to open” status.
Buy to close orders are used when you have written an option and decide to close the trade before expiration. Since you sold an option to open the trade, the closing trade will be a “buy to close.”
Sell to close orders are used when you hold a long options position. By selling, you close the trade and record a profit or loss just like a stock trade.
Market orders are executed at a price available in the market. It may not be the best price available, and, especially when prices are volatile, the price at a market order executed may not be very close to the last available price quote. Market orders guarantee a filled order but not a price.
Limit orders are executed at the stated price or better. If you enter a “buy, limit $1,” then all options contracts in the order will be bought for $1 or less. You might not be able to get an order executed at the limit price, which is a risk you need to consider. Limit orders guarantee a price but not a fill.
Stop orders become market orders when the stated price is reached. An order to “buy, stop $1” is triggered as a market order when the price rises to $1 but could be fully executed at higher prices depending on which way the market goes.
Stop-loss orders are stop orders that many traders use to manage risk. “Buy” stop orders are entered with stop prices above the market price. “Sell” stop orders have stop prices below the market price.
Stop orders can also include limit instructions. For example, “sell, stop limit $1” would become a sell order with a limit price of $1 when the price falls to $1 or below. If the price continues falling, this order might not be fully executed.
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