A Comprehensive Guide on Buying Options on Robinhood
This guide will teach you, in detail, how to enter options trades on the platform. You'll learn how retail investors can succeed on the options market, how to balance investment objectives and risks, understand how the underlying asset affects options price, and making the most of Robin hood options.
Technology continues to transform everything from the way we eat to our financial life. Financial services leverage innovative digital solutions that anyone can try to deploy for fun and profit.
When Robinhood arrived on the scene, it pioneered stock trading, exchange-traded funds, and cryptocurrencies, minus [usually hefty] commissions. The company also offers commission-free options trading, which many traders – beginning and expert – find tricky.
Stocks are not Options
People new to options trading usually think that stocks and options are the same, but that's not the case. Options trading is like stock trading in some respects, but they are not substitutes for each other.
There’s certainly some overlap between stocks and options, but both concepts have a unique purpose.
Stocks are the underlying security for options, whereas options are essentially a type of derivative security. However, options still have an intrinsic value. In the first place, their price derives from their associated underlying stock.
On the other hand, options are contractual agreements that give the buyer the right to buy the underlying stock at a specified price at a predetermined date. The seller is in a different position, however.
They have to follow through on those terms. Depending on market conditions, an option may have high value or be worth little to nothing.
Is it Riskier to Buy Options than to Buy Stocks?
It’s way easier to lose money trading options if you invest a lot of money over a certain period. Purchasing a stock is far safer; the lowest a stock can go is $0, meaning the maximum you can lose is the amount spent on buying it.
Options contract has an expiration date, and that presents a real risk. They are not like publicly traded securities that can only tank to $0 when a business fails. The predefined lifespan of an option can be dangerous for your portfolio.
If you buy options, the tendency is for you to improve your financial situation or lose your investment – a true binary affair.
This all-or-nothing scenario dramatically increases the risk profile along with the reward potential. As such, it’s essential to understand your personal risk tolerance before attempting to buy options.
Buying options allow you to limit your risk and protect your capital when you're uncertain which way the stock price will swing.
Therefore, it's advisable to comply with the platform requirements and understand what you're getting into. If you want to buy options contracts, you need to realize that financial investments involve risk, and you stand a real chance of losing money.
When you buy, though, the risk on the transaction is always limited to the premium. It's only a fraction of the cost of the stocks, but you should keep your guard up nonetheless. Success in trading depends a lot on controlling even the most negligible losses.
Why You Need to Learn the Proper Way to Buy Options on Robinhood
No matter their experience level, we find people not doing it right when buying options. This scenario typically happens because they do not have clear goals.
Clarity with your goals is essential to forging a winning strategy for buying options on Robinhood. So, do you want to save more money and grow your profits over the long term? That sounds good and is quite likely, the goal for many investors trading options on Robinhood.
Even if you've ever traded options before, sort out your goals, and we'll show you the steps to make them happen.
Let the Games Begin….
The first step in trading options on Robinhood is to ensure that you can trade options. Unfortunately, you’ll not be able to sign up on Robinhood if you’re outside the United States and the states of Hawaii, Nevada, New Hampshire, West Virginia, and the District of Columbia. Even with a VPN, you'll not be able to sign up from those states as you'll need to verify your identity using your actual address and bank account.
Besides the website, Robinhood is accessible via mobile apps on the Android and iOS platforms. Then, you’ll need to create a trading account with an email address. Your trading account will have a username and a password.
The next step is to verify your identity, after which you'll need to wait a few days for the company's approval. But that's pretty much all the waiting that you'll do.
When you choose the stock you want to trade, you also need to ensure that you have options trading permission on your profile. You'll know you have permission if you see the Trade Options button sitting just above the Sell and Buy buttons.
So, if this button is not there, even the most experienced traders won’t have a Robinhood ticket to trade options yet.
How can you get the Trade Options button on your account to enable you to buy options for a particular stock at a specific price, though? The short answer is to request permission from Robinhood.
How to enable Robinhood options
There are only a few steps to enabling options on Robinhood. Here’s a simple outline of what you should do:
- First, tap the Account button in the top right corner of your screen.
- Next, choose Settings.
- Next, go to the Options Trading section.
- Tap the Enable option.
- Answers to questions about your investment experience, knowledge, and other essential details should be furnished upon request.
Key Concepts of Buying Options on Robinhood
Buying options contracts enable you to access leverage if you’re bullish on a specific stock. But, you can also benefit from bearish price action.
To go bullish or long, you buy call options. They give you the right to purchase shares of the underlying stock (always available in 100-share slots) at a specific price) at a predetermined time (the expiration date).
Conversely, you buy put options to go bearish or short. This time, you earn the right to sell shares of an underlying stock (in 100-share slots or bundles) at the strike price, no matter the market price.
One interesting feature of options is that you do not need to wait till the expiration date to exercise them (now you see how an "option" is a "right"). As soon as the strike price is favorable to your position, that is, the options are "in the money," you may sell your options above what you paid for them.
When options are "out of the money," their value will often have a discount against the price paid for them. However, options in which the strike price matches the underlying security are "at the money."
Instead of buying brand new options, learning the art of buying calls on Robinhood lets you buy the option off someone else at a lower price, wait for the option to mature, and pocket handsome profits.
Buying calls lowers your overhead and increases your profit potential. For instance, if you purchase calls for $5 per share – the premium on the option – rather than $50 per share, you already have saved some significant sum of money.
Why some may not be able to buy options on Robinhood
Typically, Robinhood offers no support for market orders for options contracts. The main reason is the greater volatility in the options market than in the equities markets.
The system lets you know how much you’re going to pay to buy a contract. Options traders can place Good for day or Good till canceled orders.
Good for day orders will either be filled or canceled at the close of the trading session.
On the other hand, a good till canceled order remains open for 90 days until it's filled, or you cancel them before that happens.
Key terms when trading options on Robinhood
All trading platforms are unique, and Robinhood is no exception. Besides its look-and-feel, it will present a distinct outlook on trading stocks, for instance. Some of the critical aspects of options trading on Robinhood are as follows:
#1 – Expiration date
The expiration date is the most crucial factor to consider when buying options on Robinhood, and you'll find it below underlying stock and strategy.
If you scroll right, you’ll see the expiration schedule of future dates. A longer expiration date gives your options more time to become profitable. Still, you'll have to buy them at a higher premium in most cases.
#2 – Strike prices
An option's strike prices scroll vertically from high to low, allowing you to see the entire available range. After investors consider their investment objectives, they can make a more informed decision on the appropriate strike price. Different stocks will have different strike prices for their options.
#3 – Premium
The premium or predetermined price refers to the mark price of the option or, more simply, the option's value. The percent change reflects how much a particular contract has moved during the trading session.
You’ll find the premium on the right of your screen. The +/- % change represents today’s cost movement for the contract.
#4 – Break-even point
The break-even point is where the stock needs to trade at expiration to enable you to break even on your investment in terms of the price or current value of the option.
#5 – Break-even percentage
The percentage change the stock needs so you can break even at the option’s expiration.
#6 – Chance of profit percentage
The probability of your investment being profitable where you’ve chosen the Sell strategy.
Now, you know some of the key terminology you need before buying a put option or a call option.
Now that you’re in
When you tap the Trade Options button, you need you’ll get a new options screen that shows the expiration dates or dates you can buy. You choose a favorable date based on your general trading style, risk management, tolerance, and so forth.
Some seasoned traders typically trade options with a 7- to 10-day window. At this point, we're probably aren't keen on whether the stock is bullish or bearish. It just illustrates how easy it is to get in and out of an options trade without any obligation to buy or sell.
As you would expect on any trading app or platform, each option screen on Robinhood has a Buy and a Sell button.
But, there are two other buttons: a Put button and a Call button.
Call or put
The Buy and Sell buttons are on the top left, while the Put and Call buttons are on the top left. These four buttons are laid out across the top of the screen, but under the option dates where you can pick a date for the option you want.
When you’re going bearish, you tap the Put button.
This turns everything into a vibrant red color. Going bearish means you are betting that the stock (say APPL or AMZN) will fall, while going bullish means you expect the stock to rise.
However, on Robinhood, you use Call when you go bullish. Tapping that button turns everything on the screen into a nice green color. This includes the numbers and dates.
Note that these colors don’t mean you’re gaining or losing on a trade.
They’re just a way for Robinhood to tell you, “Hey! You’re in Put mode.” or “Hey! You’re in Call mode.” These visual cues can be helpful.
When you sell an option, you simply click the Sell button.
This action helps you to short the option. This guide will consider how you can go long using the Buy button.
So, we’ll toggle to Put at the top of the screen.
Once you select which Call option you’re interested in, Robinhood shows you a new screen where you type in how many contracts you’d like to own and the limit price. The limit price is how much you’re willing to pay to enter the trade.
It’s also important to check the spread of the option you’re buying. The smaller the spread, the less money you stand to lose if things go contrary to your expectations. Note that Robinhood may not give you the same spread as you find on other platforms.
How to use the stock price to your advantage
A bit more explanation on the nature of Robinhood option spreads is in order. But, first, be aware that you'll leave money on the table both ways every time you enter and exit a trade.
Now that you’ve tapped Call, you certainly have the contract in your possession, right?
Not so fast! Placing a Call order doesn’t imply that you’re in possession of the contract yet.
Sometimes, you may need to bide your time so you can buy the option for less and save more money. The option may not get filled as quickly at lower prices since more buyers stick around the buyers' bid price. Rest assured, however, Robinhood will tell you when the contract is filled.
In such cases, a fast trader may choose to click Replace Order.
This action will help you cancel the last order and get into a new contract. There might be new terms with this new contract, such as a higher price that raises the chances of getting filled quickly.
Buying around the upper limit of the spread (sellers' price) is a sure-fire way to get filled faster – say a few minutes. This method of getting into a trade ensures that you get filled fast at the best possible price. It can help to maximize your gains.
Getting out of a trade
The aim of getting out of a trade is to make as much profit as possible. You can do this by simply trading the spread. Even if the option does not rise, you can sell at the ask (or seller’s) price.
All you need is buyers and sellers moving the market as naturally as they would, and you can exit with a healthy margin off the spread.
Higher Levels of Options Trading
The more you trade options on Robinhood, you’ll have the option to advance to higher levels.
A Level 2 designation allows you to execute options trades, including long calls (and long puts), covered calls, and cash-covered puts.
On the platform, you can achieve Level 3 at most. In addition, you'll be able to execute all Level 2 trades, besides limited risk spreads such as Credit Spreads, Iron Butterflies, and Iron Condors.
Traders can sell short calls and short puts in Level 4, a level involving certain complex options strategies with unlimited potential for risk and loss.
Only the most advanced traders play on Level 4 available in Robinhood alternatives. Besides, your portfolio might be a drop in the ocean compared to theirs.
Things to Note about Robinhood
While it’s easy-peasy to jump on the Robinhood platform and trade options, some parts of the experience could be a lot better.
Anyone looking for a bare-bones or fat-free trading experience without unnecessary additives would find it in Robinhood. However, this design philosophy makes Robinhood unattractive to investors seeking a more robust trading platform.
Robinhood's desire to make financial trading accessible to everyone certainly comes at a price. In another example, its stock research tools are shockingly thin compared with $0 brokers such as Charles Schwab, Fidelity, TD Ameritrade, Thinkorswim, and Weeble. Such platforms where securities trading is offered help clients exercise options by providing tools to guarantee favorable investment outcomes.
Robinhood isn’t on the level of a competitor like Weeble in terms of customer support. There’s just nobody to speak with when you encounter problems on Robinhood, which is somewhat a dark spot on the reputation of such a promising platform.
Robinhood is a game-changer for options traders. Because it’s commission-free, it enables all levels of investors to access the options markets. Indeed, Robinhood forced other platforms to develop a trader-first philosophy in their operations. Options trading allows small traders to manage many stocks with only a fraction of the cost.
Being a public platform, its transactions remain simple enough, with more complex higher-risk strategies for advanced traders. Options trading entails significant risk, making research and patience essential. If you’re going to start out buying options, Robinhood is a great way to get your feet wet for the big leagues of investing. Like experienced traders, you'll do well to weigh risks carefully before investing in options.
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