Noob question: can somebody please explain option trading?

[melidesau]

Hi everyone!

I'm a young Canadian humanities student trying to get started with investing the money I've been saving over the past few months. I've read through the entirety of MMM's articles and have been a lurker on the forums for a few months now, and though I'm naturally a pretty frugal person the investment side of things really doesn't come easy to me.

After exploring a few different possibilities, I've decided to open a TFSA with TD and invest in e-series index funds. I've started the online application, but now it's asking me whether I want my account to have the feature "option trading", which I wasn't really anticipating and don't know much about. From a quick google of the term, it looks like a feature I don't really need since I don't plan on doing any active trading, but I wanted to check here first.

I'd really appreciate if someone could give me a simple, not-too-technical explanation of how options work and advice on whether this feature could be of use in my TFSA. Thanks!

[John G]

There are two main types of options. A call option gives you the right (but not the obligation) to purchase X shares at Y price prior to a specified future date. Similarly, a put option gives you the right (but not the obligation) to sell X shares at Y price prior to a specified future date. Only very sophisticated investors should get involved with options. Since you're just getting started, I would not worry about them.

[smedleyb]

Start here:

http://www.minyanville.com/businessmarkets/articles/6/10/2003/id/1540

[Honest Abe]

Options are not for the novice (or in my opinion, any non-professional) investor. Naked options are one step away from sitting down at a roulette table. Buying options as insurance on a security that you own has its benefits, but is not free.

[Nords]

...  and advice on whether this feature could be of use in my TFSA. Thanks!

You don't need options trading on your account for now.

If you're absolutely fascinated by the idea of using options to control leveraged amounts of money, you could read the CBOE options primer (http://www.cboe.com/learncenter/) and McMillan's textbook (http://www.amazon.com/Options-Strategic-Investment-Lawrence-McMillan/dp/0735204659/ref=sr_1_3?s=books&ie=UTF8&qid=1355702520&sr=1-3&keywords=macmillan+options).  But again, for most people options trading is a way to generate income for options market makers.  The vast majority of people who buy or sell options lose money on them because they're using them as insurance, not for profit.

[k9]

I agree with Honest Abe. This is a dangerous tool to manipulate, unless you want to use as a protection of your portfolio (but then I think it's not worth the price).

[melidesau]

Thanks everyone for your replies. I've set up my TFSA *without* options trading, and while I certainly will be reading up on it (and on many other aspects of investing... oh so many things to learn!) it will remain a purely theoretical interest for now and probably for quite some time.

[smedleyb]

Thanks everyone for your replies. I've set up my TFSA *without* options trading, and while I certainly will be reading up on it (and on many other aspects of investing... oh so many things to learn!) it will remain a purely theoretical interest for now and probably for quite some time.

In that case, I highly recommend my link above.  John Succo is an options genius.

Knowledge is power.

[sherr]

Another excellent link to explain what they are is http://www.khanacademy.org/finance-economics/core-finance

Do a text search for "American Call Options" and then watch the next few videos after that.

Khan does an excellent job of explaining things clearly and simply so they are easy to understand. Those videos will help you to understand when and if using call options is appropriate.