Embarking on the journey of options trading can feel like stepping into a complex financial labyrinth. But fear not, for with the right guidance and a clear understanding, navigating the world of call options on E*TRADE can become an empowering experience. This comprehensive guide will walk you through each crucial step, from setting up your account to executing your first call option trade, and even help you understand the nuances involved.
A Comprehensive Guide to Buying Call Options on E*TRADE
So, you're ready to dive into the exciting world of call options on E*TRADE? Fantastic! Before we even talk about specific buttons to click, let's make sure you're properly set up for success. This isn't just about placing a trade; it's about understanding the mechanics and risks involved.
Step 1: Are You Ready? Understanding Call Options and E*TRADE Requirements
Before you can even think about buying a call option, we need to ensure you're on solid ground. This initial step is paramount and often overlooked.
What Exactly Are Call Options?
Imagine you believe a company's stock, let's say "Tech Innovators Inc." (TII), currently trading at $100 per share, is poised for a significant price increase. You could buy 100 shares for $10,000. But what if you don't have that much capital, or you want to magnify your potential returns (and risks)?
This is where a call option comes in. A call option gives you the right, but not the obligation, to buy 100 shares of an underlying asset (like TII stock) at a predetermined price (called the strike price) within a specific timeframe (until the expiration date). You pay a non-refundable fee for this right, known as the premium.
Example: You buy a TII $105 call option with an expiration date three months from now for a premium of $3 per share (or $300 for one contract, as each option contract typically represents 100 shares).
If TII rises to $115 before expiration, you can exercise your right to buy 100 shares at $105, then immediately sell them in the open market for $115, pocketing a profit (minus the premium and commissions).
If TII only reaches $103, or even falls, by expiration, your option might expire worthless, and you would lose the $300 premium.
Key takeaway: Call options offer leverage, meaning a smaller capital outlay can control a larger amount of stock. However, this leverage also amplifies risk. You can lose 100% of your premium if the stock doesn't move as anticipated.
E*TRADE Account and Options Approval
To trade options on ETRADE, you'll need more than just a standard brokerage account. ETRADE, like other brokers, requires you to apply for and be granted options trading approval. This is because options are considered more complex and inherently riskier than simply buying stocks.
Opening an E*TRADE Account (if you don't have one):
Go to the E*TRADE website.
Click on "Open an Account."
Choose the appropriate account type (typically a brokerage account).
Provide personal information (name, address, SSN/TIN, employment details).
Provide financial information (liquid net worth, annual income, total net worth) – this is crucial for options approval.
Upload identification documents (government-issued ID, passport).
Review and submit your application.
Fund your account.
Applying for Options Approval (or upgrading an existing account):
Once your account is open, or if you have an existing one, you'll need to navigate to the options trading application. E*TRADE will ask you a series of questions about your:
Investment Objectives: Are you seeking income, growth, capital preservation, or speculation? For call options, it's often speculative or growth-oriented.
Trading Experience: How long have you been trading? What is your experience with stocks and options? How many trades do you make per year?
Financial Situation: Your liquid net worth, annual income, and total net worth are assessed to determine your suitability for options trading.
E*TRADE has different options approval levels (typically Level 1 to Level 4). Buying a simple "long call" (which is what we're discussing) usually falls under a lower level, but understanding the different levels is important for future strategies. Higher levels allow for more complex and risky strategies (like selling naked options).
Be honest and thorough in your application. Your answers dictate the level of options trading you'll be approved for. If initially denied, you can reapply later as your experience and financial situation evolve.
Step 2: Research and Strategy: Identifying Your Target and Plan
This is where the real work begins before you place any orders. Blindly buying options is a recipe for disaster.
Sub-heading: Identifying Potential Opportunities
Fundamental Analysis: Look for companies you believe have strong growth prospects, positive earnings reports, innovative products, or upcoming catalysts (like drug approvals, new product launches, or favorable economic data) that could drive their stock price higher. E*TRADE provides a wealth of research tools, including analyst reports, news feeds, and financial statements.
Technical Analysis: Study stock charts to identify trends, support and resistance levels, and potential breakout points. Technical indicators can give you clues about momentum and likely price movements. Power E*TRADE, their advanced trading platform, offers robust charting tools.
Sector Analysis: Consider broader industry trends. Is there a sector that is poised for significant growth? Identifying strong sectors can help narrow down your stock selection.
Sub-heading: Building Your Trading Strategy
Before you commit capital, you need a clear outlook and a well-defined plan.
Outlook: What do you believe the underlying stock will do? Will it go up significantly? By how much? When do you expect this to happen? Options are time-sensitive, so your timeframe is crucial.
Profit Target: What is your desired profit from this trade?
Maximum Acceptable Loss: How much are you willing to lose if the trade goes against you? This is vital for risk management.
Risk/Reward Ratio: Assess the potential profit versus the potential loss. A favorable risk/reward ratio is generally desired.
Step 3: Selecting Your Call Option: Strike Price and Expiration Date
Now that you have a target stock and a strategy, it's time to pick the specific call option contract. This involves two critical decisions.
Sub-heading: Choosing the Strike Price
The strike price is the price at which you have the right to buy the underlying stock.
In-the-Money (ITM) Calls: Strike price is below the current stock price. These are more expensive but have intrinsic value and a higher probability of expiring profitably. They require less upward movement in the stock to become profitable.
At-the-Money (ATM) Calls: Strike price is equal to the current stock price. These offer a good balance of cost and potential leverage.
Out-of-the-Money (OTM) Calls: Strike price is above the current stock price. These are cheaper but have no intrinsic value and a lower probability of expiring profitably. They require a more significant upward movement in the stock price to become profitable, but offer the highest leverage.
Consideration: Your choice depends on your price target and risk tolerance. If you expect a massive surge, an OTM call might offer greater percentage returns. If you're more conservative, an ITM or ATM call might be preferable. Remember, the further OTM you go, the cheaper the option, but also the higher the probability of it expiring worthless.
Sub-heading: Selecting the Expiration Date
The expiration date is the last day your option contract is valid.
Short-Term Options (Weeklys, 1-3 months): These are cheaper but highly sensitive to time decay (theta). They require quick, significant moves in the underlying stock.
Mid-Term Options (3-6 months): Offer a balance of time and cost.
Long-Term Options (LEAPs - Long-term Equity Anticipation Securities, 6 months to 2+ years): These are more expensive but less susceptible to time decay, giving the underlying stock more time to move. They can be used for longer-term directional bets.
Consideration: Align your expiration date with your investment horizon and the expected timing of your catalyst. If you anticipate a major event next month, a short-term option might be appropriate. If your thesis is based on a longer-term trend, a LEAP might be better. Remember, time is money when it comes to options!
Step 4: Placing Your Order on E*TRADE: The Order Ticket
Once you've done your homework and chosen your contract, it's time to enter the order.
Sub-heading: Navigating to the Options Chain
Log in to your E*TRADE account.
Search for the underlying stock's ticker symbol (e.g., TII) using the search bar.
On the stock's quote page, look for an "Options" tab or link. Clicking this will take you to the options chain.
Sub-heading: Understanding the Options Chain
The options chain will display a table of available call and put options for various expiration dates and strike prices.
You'll see columns for:
Expiration Dates: Listed at the top or in a dropdown.
Strike Price: The price at which you can buy (calls) or sell (puts) the underlying.
Last Price (Premium): The last traded price of the option contract.
Bid/Ask: The current highest price buyers are willing to pay (bid) and the lowest price sellers are willing to accept (ask).
Volume: Number of contracts traded today.
Open Interest: Total number of outstanding contracts.
Implied Volatility (IV): This is a crucial metric that reflects the market's expectation of future price swings. Higher IV generally means higher option premiums.
Sub-heading: Building Your Order Ticket
Select the Expiration Date: Click on the desired expiration date from the options chain.
Locate the Call Option: Scroll down to the "Calls" section and find your chosen strike price.
Click on the Ask Price: To buy a call option, you typically click on the "Ask" price for the specific contract you want. This will pre-populate the order ticket.
Review the Order Ticket:
Action: Ensure it says "Buy to Open" (since you are initiating a new position).
Symbol: Verify the correct underlying stock and option contract.
Quantity: Enter the number of option contracts you wish to buy (each contract represents 100 shares).
Order Type:
Market Order: Executes immediately at the best available price. Avoid for options unless you are comfortable with potential price slippage, especially for less liquid options.
Limit Order: Allows you to specify the maximum price you are willing to pay per contract. This is generally recommended for options to control your entry price.
Other advanced order types exist (Stop, Stop Limit), but for a basic long call, a limit order is usually sufficient.
Time in Force:
Day: The order remains active until the end of the trading day.
Good 'Til Canceled (GTC): The order remains active for a specified period (e.g., 60 days) or until filled or canceled.
Preview Order: Always preview your order before submitting. Double-check all details, especially the action, symbol, quantity, price, and expiration.
Place Order: If everything looks correct, click "Place Order."
Step 5: Monitoring Your Position and Creating an Exit Plan
Buying the option is just the beginning. Successful options trading involves active management.
Sub-heading: Tracking Your Investment
E*TRADE Portfolio: Regularly check your E*TRADE portfolio to see the current value of your option position.
Price Movements: Monitor the price of the underlying stock closely.
Time Decay (Theta): Be aware that as time passes, the value of your option will erode (unless the stock moves significantly in your favor). This is particularly true for OTM options as they approach expiration.
Implied Volatility (IV) Changes: A sudden increase or decrease in implied volatility can significantly impact the option's premium. For call buyers, an increase in IV is generally beneficial, while a decrease is detrimental.
Sub-heading: Your Exit Strategy
Most successful traders have a predefined exit strategy to lock in gains and manage losses.
Profit Target Exit: If the underlying stock reaches your price target and your option has appreciated sufficiently, consider selling the call option to realize your profit. You don't have to wait until expiration.
Stop-Loss Exit: Define a maximum loss you are willing to accept. If the option's value falls to that point, sell it to limit your downside. This is crucial for risk management.
Before Expiration: Don't feel obligated to hold the option until expiration. If your thesis changes, or if the option is deep in the money and you want to lock in profits, you can always close the position.
Exercising vs. Selling: While you have the right to exercise a call option to buy the underlying shares, most retail traders sell the option before expiration to profit from the premium appreciation, avoiding the capital commitment of buying the shares. Exercising is typically only done if you truly want to acquire the underlying stock.
Step 6: Adjusting or Closing Your Position
The market is dynamic, and your trading plan should be too.
Sub-heading: Managing Your Trade
Rolling Options: If your option is performing well but you believe the underlying stock has more room to run, you might "roll up and out." This means selling your current profitable option and buying a new call option with a higher strike price and/or a later expiration date. This can extend your trade and potentially increase your profit potential.
Hedging: For more advanced strategies, you might consider using other options (like put options) to hedge your call option position, though this adds complexity.
Sub-heading: Closing Your Position
To close your call option position, you will execute a "Sell to Close" order.
Go to your E*TRADE portfolio and locate the call option you wish to close.
Click on the option, and you should see an option to "Sell" or "Close Trade."
The order ticket will pre-populate with "Sell to Close."
Enter the quantity you wish to sell.
Choose your order type (typically a limit order to ensure you get a favorable price).
Preview and submit your order.
Remember: Options trading involves significant risk and is not suitable for all investors. Always educate yourself thoroughly and understand the potential for loss before trading. Consider starting with a small amount of capital you are comfortable losing. E*TRADE also offers paper trading accounts (simulated trading) which can be an excellent way to practice without risking real money.
10 Related FAQ Questions about Buying Call Options on E*TRADE
Here are some common questions you might have as you delve into buying call options on E*TRADE, with quick answers:
How to Get Approved for Options Trading on E*TRADE?
You need to apply for options trading approval within your ETRADE account by providing information about your investment objectives, trading experience, and financial situation. ETRADE assesses this to determine your suitable options trading level.
How to Understand the Fees for Buying Call Options on E*TRADE?
E*TRADE generally charges a commission per contract for options trades. As of recent information, this is around $0.65 per contract, potentially dropping to $0.50 per contract if you execute 30 or more trades per quarter. Regulatory and exchange fees may also apply.
How to Choose the Right Stock for a Call Option?
Focus on stocks where you have a strong bullish conviction, ideally with upcoming catalysts or favorable fundamental and technical indicators that suggest a significant upward price movement in the near to medium term.
How to Select the Best Strike Price for a Call Option?
This depends on your risk tolerance and price target. OTM (Out-of-the-Money) calls are cheaper and offer more leverage but require larger stock movements. ITM (In-the-Money) calls are more expensive but have a higher probability of profitability and less leverage. ATM (At-the-Money) calls offer a balance.
How to Determine the Ideal Expiration Date for a Call Option?
Align the expiration date with your investment horizon and the expected timing of the catalyst that will drive the stock price up. Longer-dated options (LEAPs) give more time but are more expensive; short-term options are cheaper but highly sensitive to time decay.
How to Read an Options Chain on E*TRADE?
The options chain displays available options contracts. For calls, you'll see columns for strike price, last traded price (premium), bid/ask, volume, open interest, and implied volatility, organized by expiration date.
How to Use a Limit Order When Buying Call Options?
A limit order allows you to specify the maximum price you are willing to pay for the option contract. This helps you control your entry price and avoid significant price slippage, especially with less liquid options.
How to Monitor the Performance of My Call Option?
Regularly check your E*TRADE portfolio. Pay attention to the underlying stock's price, the option's premium, time decay (theta), and changes in implied volatility, all of which affect your option's value.
How to Close a Call Option Position on E*TRADE?
To close a long call option position, you will place a "Sell to Close" order for that specific option contract through your E*TRADE portfolio or the options chain.
How to Manage Risk When Trading Call Options?
Always define your maximum acceptable loss before entering a trade. Consider using stop-loss orders or setting mental stop-loss points. Diversify your options portfolio and never risk more capital than you can afford to lose.