If you're thinking about trading options, one of the first questions you might have is how much money you'll need. The quick answer is not much! You can start very small. But the cost of options can vary dramatically depending on your strategies and which stocks you'd like to trade.
We'll break it all down for you so you'll know how much money you'll need to get started trading options today. (Make sure to check out our complete guide on how to trade options too).
First, let's take a look at the different prices of options trades, and then we'll look at how you can lower your costs...
How Much Options Trading Costs
While you can create all sorts of strategies from individual call or put buying to complex, multi-option creations, most traders keep it simple. In general, the simpler the trade, the lower the cost.
Take a look at call options on a stock like Ford Motor Co. (NYSE: F). A call option with a strike price of $13.50 expiring in just over a month will run you $32. The option gives you the right to buy 100 shares of Ford at $13.50 a share. So, if you expect the stock to climb higher than that, this is a much, much cheaper strategy than just buying 100 shares of Ford today. That would set you back $1,226.
As you can see, for a fraction of the cost, you can grab your piece of the action. And don't forget, with such a low up-front cost, your risk is also just a fraction of the stock's risk.
But there are still some options that will cost a lot of money. These are typically options on stocks with very high dollar prices. Take a look at Amazon.com Inc. (NASDAQ: AMZN) call options expiring in three months away with a strike price right at the current price of the stock. Each option would cost about $18,500. That's still quite a bit cheaper than buying 100 shares of Amazon - over $3 million - but it's quite a big chunk of change for most investors.
Fortunately, there are options strategies that can cut these costs down considerably...
How to Lower the Cost of Options
You're not stuck with just buying options. You can also sell options. Even better, you can combine options buying with options selling to create a lower-cost trade overall.
Called a "spread trade," we can buy the expensive call and sell a slightly less expensive call to partially offset the cost. Both options are on the same underlying stock and expire at the same time, so the only difference is the strike price.
For call options, the lower strike generally commands a higher price than the higher strike. This is because it becomes profitable at a lower price level on the underlying stock. Typically, we would buy the call with a strike just under the current stock price and sell the call with a strike just above it.
Take Amazon for example again. For the Amazon call, we can buy the $3,140 strike for $18,500 and sell the $3,160 strike at $18,145. The net cost would be just $355. That's less than it would cost to buy just one share of the stock.
There's a catch though. The call you sell caps your upside potential. But if you think the underlying stock will move up just modestly, you can profit from it at a much lower cost and much lower risk.
Don't forget: Amazon has a huge dollar price. Stocks with more "reasonable" prices will offer more flexibility and more opportunities to make money, whether you just buy calls or puts or you use spread trades.
So far, we've focused on buying options, but you can make money by selling them, too.
You Can Sell Options Too
You don't need any money to sell options, but we wouldn't recommend it. It comes with heightened and unique risks. But there are safe and smart ways to do it.
The most common way investors sell options is in a "covered call" trade where you sell a call option against a stock you already own. Since you already have at least 100 shares of the stock, you will not be exposed to unlimited risk if your option trade moves against you. The stock "covers" your risk.
The idea of a covered call is to sell the call options and hope they do not get exercised. In other words, the price of the underlying stock does not move substantially higher. In that case, the option expires worthless, and you keep the money you got from selling the call. You can create a nice income stream doing this over and over.
Don't forget - with zero commission trading available at many brokers, selling options costs you nothing (other than keeping reserve cash in your account).
The bottom line is that you don't need a ton of money to trade options, and many brokers have very low dollar trading limits. Even some of the best trades the pros, like Tom Gentile, recommend only cost a few hundred dollars to do, and they can still return upwards of 100% or more on your money.
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