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Beginner’s Guide to Options: How to Get Started

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Options trading can become quite complex, but at their heart, options are all based on a basic formula. An option is a right to buy or sell a security at some future date at some specific price. Those specifics are governed by the option contract. Investors find options interesting because of the potential to earn huge returns, though that comes at the cost of risking a significant loss.

If you’re looking to get started in the world of trading options, here’s what you need to know about them.

What is an option?

An option is a contract between a buyer and seller that entitles the option buyer to purchase or sell a security, usually a stock, at a given price — the strike price — by a certain time.

Options are essentially a bet on which way a stock will move. Buyers pay the seller a fee, called a premium, and if the “underlying” stock finishes above or below the strike price (depending on the option type) when the option expires, it’s worth money.

There are generally two outcomes for an option:

  1. If the underlying stock doesn’t make the buyer’s anticipated move, the option expires worthless. When this happens, the buyer loses the premium and the seller keeps it. The seller’s profit is the buyer’s loss.
  2. If the underlying stock does make the anticipated move, the option is “in the money.” The option’s profit is the difference between the strike price and the stock price. In this case, as the option nears expiration, the buyer typically exercises the option — either putting up cash to buy the stock or selling it at the strike price, depending on the type of option — and records a profit. The buyer’s profit is the seller’s loss.

One option is called a contract, and each contract represents 100 shares of the stock. For example, if you buy or sell three contracts, your options position tracks the movement of 300 shares of stock.

Options allow investors to capture a stock’s movement while paying a much smaller upfront cost, the premium. This means that options can allow investors to enjoy the full upside of a stock’s move without paying the stock’s full price — that’s the real attraction of options trading.

In other words, options magnify the returns, both on the upside and on the downside. While an investor can earn virtually unlimited upside, he or she also can suffer a complete loss of the premium paid.

Types of options: calls and puts

There are two broad types of options — call options and put options — and they entitle buyers and sellers to different things. Here’s a quick way to keep calls and puts straight: Calls become more valuable when the stock rises, while puts become more valuable when the stock falls.

A call option specifies the price at which a stock can be purchased by some future date, and this option increases in value as the stock rises.

  • A call buyer expects the stock to go up, making the option more valuable. A call buyer profits when the option’s premium costs less than the difference between the stock price and the strike price at expiration.
  • A call seller (or writer) expects the stock to fall or stay flat, making the option less valuable. A call writer profits when the option’s premium costs more than the difference between the stock price and the strike price at expiration.
  • A put option specifies the price at which a stock can be sold by some future date, and this option increases in value as the stock falls.
  • A put buyer expects the stock to go down, making the option more valuable. A put buyer profits when the option’s premium costs less than the difference between the stock price and the strike price at expiration.
  • A put seller (or writer) expects the stock to rise or stay flat, making the put less valuable. A put seller profits when the option’s premium costs more than the difference between the stock price and the strike price at expiration.

One thing to note on employee stock options: Sometimes companies grant employees stock options as a perk of employment. These options entitle employees to buy the company’s stock at a specified price by a certain time, usually much longer than options that are found on the exchanges.

Employee stock options are always call options — no management team would want to allow its employees to wager on the company’s decline. These stock options usually will expire worthless if the employee does not exercise them, and they do not trade on an exchange.

How options trade

While it’s most common to talk about options with stock as the deliverable, there can be options on almost anything — even, perhaps most famously, on movie scripts. Regular options on an exchange can be written on stocks, exchange-traded funds and major indexes such as the S&P 500 and the Dow Jones Industrial Average.

Still, stocks are the most common deliverable, though not all stocks have options. A highly liquid options market — having lots of buyers and sellers — exists on primarily the largest and most liquid stocks. The market’s smallest stocks may not have much (or any) options activity, or the market may not even exist for them.

Stocks with options on them usually have one option expiring each month, on the third Friday of the month. However, higher-volume stocks may have options that expire on a weekly basis.

The most liquid options markets have another feature not available in less liquid markets: long-term options called long-term equity anticipation securities (LEAPS). That’s a clunky name for options with expirations that go out as far as two years or so. In other respects, they function like standard options. LEAPS give traders more for their bet to be right.

Are options risky?

Yes and no. Any financial security can be risky if investors don’t know what they’re doing, and so it is with options. Because options magnify the upside and downside of an investment, they can be risky in some situations. But in other situations, investors actually can use options to reduce risk. The key thing to understand is how options expose the investor to gains and losses.

Two important points in this regard:

  • An option buyer can never lose more money than he or she invests. A buyer’s loss is capped at the total amount of the investment. In exchange, the buyer could earn nearly upcapped gains.
  • Conversely, an option seller can lose more than he or she receives in premium income. A seller can lose many times the value of the premium received and may even have to send more money to the brokerage to cover the loss. The loss can be uncapped.

It’s important to re-emphasize that an option buyer can lose the entire premium if the stock does not make the expected move in share price by expiration. So, not only must the investor predict where the stock will move, but he or she must get the timing right too. If not, the seller pockets the premium.

What are some basic options strategies?

Based on these principles, some options strategies have limited risk (and some are even used by risk-averse retirees).

  • Call buying: potentially unlimited upside at the cost of the premium
  • Put buying: very high upside at the cost of the premium
  • Covered calls: selling a call when you already own the underlying stock, a retiree favorite

Meanwhile, other options strategies can have significant risk.

  • Naked calls: Writing a call when you don’t own the underlying stock exposes you to potentially unlimited loss if the stock rises.
  • Put writing: Expect a sizable loss if the stock falls markedly.

However, used in moderation and with lower-risk strategies, options can increase an investor’s total return.

Is options trading right for you?

Options trading typically works best for investors who want to be actively involved in the market. You won’t need to trade every day or even every week, but you have to pay attention to the market, where stock prices are heading and what might move them. That requires a significant time commitment.

So, if you’re unwilling or unable to make this kind of commitment, trading options probably isn’t for you. That’s fine because many studies have shown that passive investors — those who buy a fund and simply hold — tend to do better than active investors.

But if you’re still interested in giving options a go, you’ll want to understand your own risk tolerance and temperament. Like investing in stock, options investing is best for those with an even temperament and those who are able to emotionally handle the fact that they’re trading the possibility of major downside with the chance for significant upside.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

James F. Royal, Ph.D.
James F. Royal, Ph.D. |

James F. Royal, Ph.D. is a writer at MagnifyMoney. You can email James here

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Investing

How to Invest: A Guide for Novice Investors

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

You’ve heard this line over and over again: To be smart with your money, you need to both build your savings and invest. The savings part is easy: Stash money away in a savings account — a little at a time — to pay for a particular goals, like an emergency fund or a new car. Investing is a different story, and learning how to buy securities that will grow in value over time isn’t quite so simple.

Investments are made for the long-term, and investing involves taking on risk. That might make you nervous, but investing is essential for your financial health. Compound interest and market gains can help your money grow a much higher rate than a savings account, helping you build long-term wealth for your retirement.

How to invest in 5 easy steps

The idea of investing might be intimidating, but don’t worry, it’s not as hard as you think. In fact, you can learn how to invest and get started in just five simple steps.

1. Start investing early

When you’re young, time is on your side. That’s especially true when it comes to investing. And the earlier you start the better, according to Dr. Brandon Renfro, a certified financial planner and an assistant professor of finance at East Texas Baptist University.

“Earnings from investments compound over time,” Dr. Renfro said. “The longer you give yourself to earn that compound return, the more money you will have when you reach a goal, such as retirement.”

For example, let’s say you invest $1,000 when you’re 25 in an investment account that earns 5% interest, compounded annually. Even if you don’t save another dime, your account will be worth $2,653.30 by the time you’re 45. Without you doing anything at all, your money more than doubled. If you continue to contribute some money to your account each month, your money could grow even more, and the longer you let your money sit in an investment amount, the more it will increase in value.

The market fluctuates, moving up and down, dramatically sometimes. But over the long term, the market produces regular returns. According to the financial firm Morningstar, the long-term average return from the stock market is near 10%.

Investing while you’re young allows you to ride out any short-term losses so you can take advantage of gains over the long-term. Even if the market dips over the near term, over the 20- to 30-year timeframe, you’ll see reliable growth rates.

2. Decide how much to invest

When deciding how much to invest, it’s important to take your goals into consideration. If you have high-interest debt or if you don’t have an emergency fund, it may make more sense to pay down your debt and build a small savings account before you invest.

After that, think about your long-term goals, such as planning for retirement. You’ve likely heard experts recommend that you save millions of dollars, but don’t let that scare you. When you’re just starting out, it’s important to start saving whatever you can and to keep contributing consistently.

Vanguard, one of the biggest investment companies, recommends that you save 12% to 15% of your income for retirement. If that sounds impossible right now, save what you can afford, even if it’s just $25 per month. Over time, those small amounts will snowball, helping you build a sizeable nest egg.

If your employer offers a 401(k) retirement plan and matches contributions, try to contribute enough to qualify for the full match. That’s free money you’d otherwise leave on the table.

3. Understand what you invest in

When you’re ready to start investing, it’s important to think about what kind of account you want to open. There are three core investment account types:

  • Employer-sponsored plans: Some employers offer retirement investment accounts to their employees, such as a 401(k) or 403(b). You may even be eligible for an employer contribution match, putting more money toward your goals. There are tax benefits to contributing to these plans, helping you save money at tax time.
  • Individual retirement accounts (IRA): An IRA is a great way for you to start saving for retirement on your own, outside of an employer-sponsored plan. There are traditional IRAs and Roth IRAs, which both offer tax benefits.
  • Individual investment accounts: Another way to save is by investing in an individual taxable account. There are no tax benefits to these accounts, but they also don’t have limitations on contributions or withdrawals like employer-sponsored plans or IRAs do. If you’re saving for a goal beyond retirement, like buying a home, an individual investment account is the best choice.

According to Natalie Pine, a certified financial planner and managing partner of Briaud Financial Advisors, IRAs and employer-sponsored accounts are strong starting points.

“There is no wrong way to save, but when you are young, a Roth IRA, 401(k), 403(b) is a great option,” Pine said. “You pay low taxes now and have tax-free growth for the rest of your life and the lives of your beneficiaries.”

Once you’ve chosen an account structure, you can think about what type of asset classes and investments you want to make. There are several different investment options:

  • Stocks: When you buy a stock, you’re purchasing a share of a company like Apple or Google. Your gains or losses are dependent on the company’s performance and trends in the stock market.
  • Bonds: Bonds are loans you make to the government or corporation in exchange for interest payments over a set time period.
  • Mutual funds: With a mutual fund, you pool your money together with other investors to purchase a mix of stocks, bonds, and other securities that would otherwise be too expensive to purchase on your own.
  • Exchange traded funds (ETFs): Like mutual funds, ETFs are pooled investment options that allow you to invest in a diversified portfolio. However, they’re traded like stocks on the stock exchange.
  • Index funds: An index fund follows the performance of a specific market benchmark, such as the S&P 500 Index. The fund’s manager will a preselected collection of hundreds or even thousands of stocks and bonds, diversifying your portfolio.
  • Options: When you invest in options, you create a contract that allows you to buy or sell a security at a fixed price within a specific period of time.
  • Cryptocurrency: Cryptocurrency is a digital representation of assets used to buy and sell goods; one of the most well-known versions is bitcoin. It’s a very risky and volatile investment options, but it’s gaining popularity.

4. Choose an investment strategy

Next, think about your investment strategy. Consider your own risk tolerance. Some people are comfortable taking on more risk, thinking it’s worth it to potentially see high returns. Others get panicky when they see the market dip, and prefer more conservative investments that offer lower, steadier returns. Choose an investment strategy that works for your comfort level.

When it comes to your financial goals, consider how long you have until your target date. For example, if you’re planning on retiring in 30 years, you can choose a more aggressive portfolio that’s more heavily invested in stocks.

If your goal is in the short-term, like you plan on buying a home within the next five years, you want to invest more conservatively. You may put your money in a high-yield savings account or invest in low-risk bonds.

The most important part is simply getting started.

“While it is important to plan, don’t let the details overwhelm you to the point of inaction,” advised Dr. Renfro. “It’s better to get started now understanding just the basics than to keep putting it off.”

If you’re feeling overwhelmed, consider investing through a robo-advisor. With this approach, an online broker like Betterment or Wealthfront reviews your financial goals and risk tolerance and comes up with a comprehensive investment plan for you.

The robo-advisor will invest your portfolio in a range of ETFs, mutual funds, stocks, or bonds, and will rebalance your portfolio as you approach your investment target dates. Many robo-advisors have low fees, and have no account minimums, so you can invest even if you don’t have a lot of money.

Check out the best robo-advisors of 2019 to get started.

5. Automate your investments

According to Pine, consistency is key to your success as an investor.

“With regard to investing, consistency is essential to avoid emotions driving decisions that ultimately lead to poor performance,” she said. “If you stick with a system, whatever that may be, you are more likely to weather various storms than if you trade around a lot and catch investments at the wrong time.”

Making regular contributions will help you build long-term wealth. When you’re short on cash each month, finding extra money to invest may feel impossible. However, there are different strategies you can use to invest, even if you don’t have a lot of cash:

  • Pick an investment account with a low minimum: Some discount brokers have very low account minimums. For example, Fidelity and Charles Schwab have $0 minimums, so you get started with just a few dollars.
  • Invest your spare change:Investment apps like Acorns allow you to engage in micro-investing, where you invest your extra change. The app syncs to your bank account or credit card. Every time you make a purchase, the app rounds it up to the next dollar, and deposits the difference to your investment account. For example, if you pay $2.53 for a cup of coffee, the app would deposit $0.47 into your investment account. Over time, those small amounts can add up.
  • Set up recurring contributions: If possible, set up recurring withdrawals into your investment account. Setting up automatic deposits will take out the money before you can mentally spend it, helping you stay on track.
  • Deposit windfalls: If you receive any money unexpectedly, such as a bonus at work, your tax refund, or a gift from a relative, deposit that money directly into your investment account. It’s extra cash, so you won’t need it to make ends meet, and it can help you reach your long-term goals.

Always keep learning

As a new investor, the most important thing to do is to get started as soon as possible. The earlier you invest, the more time your money has to grow.

After you’ve opened an account and made your initial investment, spend some time learning about your investment options. There’s always something new to learn, and growing your knowledge base can help you make more informed investment decisions, which can pay off over the long run. And keep reading on MagnifyMoney to learn more about investing!

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kat Tretina
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Kat Tretina is a writer at MagnifyMoney. You can email Kat here

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Ally Invest Review 2019

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

If you’re looking for an online discount broker with no minimum investment requirement, Ally Invest may be perfect for you. Ally Invest is an ideal choice not just because you don’t need a fortune to open an account, but also because commission fees for trades are well below many competitors — especially for active traders who can earn discounts.

While Ally Invest is missing some common tools for investment research and their mobile app isn’t as feature-rich as some competitors, their full-featured online platform makes up for what the mobile app lacks. And, there’s a wide range of account options with Ally Invest, so you’re covered whether you want a taxable account, a retirement account, or an account for your kids.

Ally Invest
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The Bottom Line: Ally Invest is an affordable discount broker with a wide range of investments to choose from.

  • Commissions are just $4.95 or $3.95 if you’re an active trader.
  • There’s no minimum deposit required for a self-directed trading account, and no minimum account balance requirement.
  • Ally Invest offers tons of investment options, including stocks, bonds, mutual funds, options, futures and forex.

Who should consider Ally Invest

If you’re looking for an affordable investment account, Ally Invest should be at the top of your list. You’ll have many choices for different types of accounts with Ally Invest, including traditional and Roth IRA, IRAs for the self-employed, taxable investment accounts, 529 Plan, and more. And, you won’t have to make a minimum deposit to open your account — it’s free.

Once you’ve got your account open, Ally Invest makes trading affordable for most investments. Commissions for stock trades are among the lowest of any online discount broker, and Ally Invest offers more than 100 commission-free ETFs. If you’re looking to buy Mutual funds though, you’ll pay a transaction fee, whereas some competitors offer ample fee-free options.

Ally Invest’s online trading platform is easy to use, and their research tools are good. While you won’t find earnings transcripts, SEC filings, earnings press releases or audio calls, you can still dig into technical data using free screeners and other tools powered by Recognia.

If you don’t want to manage all the investments on your own, you can opt for a managed account. This is Ally’s robo-advisor option — but you’ll need a minimum of $2,500 if you’d prefer this hands-off approach rather than a self-directed trading account.

Ally Invest fees and features

Current promotions

New Ally Invest accounts accounts receive 90 days of commission-free trades, up to $500 in value, regardless of deposit amount. Cash bonuses are available for new accounts starting at $50 for if you deposit or transfer at least $10,000.

Stock trading fees
  • $4.95 per trade
  • $3.95 per trade (30+ trades per quarter or daily balance of $100,000 or more)
Amount minimum to open account
  • $0
Tradable securities
  • Stocks
  • ETFs
  • Mutual funds
  • Bonds
  • Options
  • Futures / commodities
  • Forex
Account fees (annual, transfer, inactivity)
  • $0 annual fee
  • $50 full account transfer fee
  • $50 partial account transfer fee
  • $0 inactivity fee
Commission-free ETFs offered
Mutual funds (no transaction fee) offered
Offers automated portfolio/robo-advisor
Account types
  • Individual taxable
  • Traditional IRA
  • Roth IRA
  • 529 Plan
  • Joint taxable
  • Rollover IRA
  • Rollover Roth IRA
  • Coverdell Education Savings Account(ESA)
  • Custodial Uniform Gifts to Minors Act (UGMA)/Uniform Transfers to Minors Act (UTMA)
  • SEP IRA
  • SIMPLE IRA (Savings Incentive Match Plan for Employees)
  • Trust
Ease of use
Mobile appiOS, Android , Windows phone
Customer supportPhone, 24/7 live support, Chat, Email

Strengths of Ally Invest

Ally Invest has plenty of strengths to help it stand out from the competition, including the following:

  • Low commissions: You pay just a $4.95 commission with Ally Invest, which is one of the lowest commissions charged by discount brokers and well below the $6.95 charged by competitors including E-Trade and TD Ameritrade. Plus, if you make more than 30 trades per quarter or have a daily balance of $100,000 or more, your commission is even lower — it drops to just $3.95.
  • No minimum deposit required: While competitors such as E-Trade require a $500 minimum deposit to open an account, Ally doesn’t have any minimum initial deposit requirement. You can also earn a cash bonus for opening an Ally Invest account if you deposit or transfer just $10,000, compared with a $25,000 minimum to earn a cash bonus with E-Trade or $20,000 with Merrill Edge.
  • Powerful tools and intuitive trading platform: Ally Invest’s online site offers you powerful tools to screen investments. Its trading platform is intuitive and provides the features necessary to be an informed investor. This includes a dashboard you can customize to your preferred view, as well as real-time streaming quotes and up-to-date data.
  • Responsive online and phone customer service: You can contact Ally Invest via phone 24/7. There’s also an online chat feature, where you can get answers within seconds from helpful customer service agents. Email support is available as well.

Drawbacks of Ally Invest

Ally Invest also has some downsides to consider:

  • Mutual fund transaction fees: Ally Invest charges a $9.95 transaction fee per trade for no-load Mutual funds. But many competitors offer options without any transaction fees, including E-Trade, which offers more than 4,400 fee-free funds.
  • A mobile app with minimal features: While you can do the basics with Ally Invest’s mobile app, it offers far fewer features and investment tools than competitor apps such as TD Ameritrade Mobile.
  • No physical branches: Ally Invest is an online-only company. There are no physical branches, unlike for competitors such as Merrill Edge, or E-Trade which has more than 30 branches spread across the country.

Is Ally Invest safe?

Ally Invest is a trusted online brokerage with more than $4.7 billion in assets under management. It’s a member of the FDIC and SIPC, so you can rest assured that the cash in your accounts is safe. And since the company has passed its FINRA broker check, you can count on the fact it’s in full compliance with regulations.

Since Ally Invest is online-only, it’s important to review Ally’s data protection policies. The good news is Ally promises that they use “multiple levels of security” to keep your info safe. This includes 128-bit SSL encryption for any exchange of data from your browser and Ally’s servers if your personal information is being transmitted. The downside, however, is that Ally’s privacy policy does permit Ally to share your information with third-parties. While this is a common policy, it’s still disappointing.

Of course, once you invest your money, there’s always a risk of losses. Research what you’re investing in carefully and diversify your portfolio to minimize risks you’re taking.

Bottom line

Thanks to the fact it has no minimum deposit requirement, Ally Invest is a great choice if you’re looking to get started investing and you don’t have a ton of money. Affordable commissions and commission-free ETFs also give you a diverse offering of low-cost or no-cost investment options. But if you’d prefer to buy Mutual funds without paying transaction fees or want a physical branch to visit, alternatives such as E-Trade or Merrill Edge may be a better choice to meet your needs.

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on Ally Invest’s secure website

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Christy Rakoczy
Christy Rakoczy |

Christy Rakoczy is a writer at MagnifyMoney. You can email Christy here