Learning how to trade options on Robinhood is a great way to get into the options market because Robinhood offers commission free on options and no contract fees. That’s one of the reason Robinhood’s user base has grown by 3 million new users in the first part of 2020 alone.
Options can give investors a lot of leverage, which makes them an appealing new asset to explore. There’s also risk, especially if you don’t know what you’re doing or falling for investor FOMO fueled by social media stock market tips.
Below you’re going to learn everything you need to know about option trading on Robinhood, including basics, Robinhood-specific options trading information, how to avoid risky bets, and the exact steps to buy options on Robinhood.
How to trade options on Robinhood in 2021
Options trading basics
Before we get too deep into options trading on Robinhood, I want to make sure you understand the basics of options trading. This is a good refresher if you’ve traded options before, but it’s incredibly important for new investors who want to learn how to trade options.
An option gives investors the ability to buy or sell an underlying asset at a predetermined price over a certain period of time. Investors aren’t obligated to buy or sell, but they have the right to, and that’s an important distinction.
To understand more about how options trading works, here are a few key terms you need to know:
- Premium: The price of buying or selling an option contract, and Robinhood lists these on the right of their options trading platform
- Strike price: The agreed upon price of the security a outlined by the option contract -- Robinhood lists these high to low, and you can scroll through the platform to see different strike prices
- Expiration date: Date and time when the contract ends, and it’s displayed below the strategy and underlying security on Robinhood’s options trading platform
- Call option: Kind of option that gives you the ability (not obligation) to buy an underlying asset at a specific price. Robinhood allows long calls and covered calls.
- Put option: Type of option that gives you the ability (not obligation) to sell an underlying asset at a specific price.
- Good-til-Canceled orders: These orders stay open for 90 days or until you cancel it
- Good-for-Day orders: This order type is automatically cancelled at market closed on the day it’s executed
Options are an asset class, like stocks or ETFs, and you can trade options contracts in the same way you trade stocks. But there’s a major difference between trading a stock vs. option: buying options means you’re buying a contract that allows for potential ownership.
There are a number of advantages to learning how to trade options on Robinhood (or any other brokerage), but leverage and flexibility are two of the biggest. An investor can exercise their option if the conditions are in their favor, but they can walk away if not.
You’re still out the price of the premium (cost of buying the option) if you decide not to exercise your option, but that’s where leverage comes in. You’re getting exposure to the market without as large of a financial commitment.
Options trading fees on Robinhood
Robinhood entered the online brokerage scene in 2013 and immediately gained disruptor status by offering commission free. That’s zero dollars to trade stocks, ETFs, and commissions.
Robinhood doesn’t even charge option contract fees, which is pretty incredible considering brokerages typically charge anywhere from $0.40 to $1.50.
M$M tip: If you’re wondering how Robinhood is able to offer zero commission trades, I highly recommend reading How Robinhood Makes Money.
Robinhood’s options trading tiers
Options trading is a more advanced trading strategy, which means brand new investors should avoid it until they understand how the stock market works. To mitigate the risk, Robinhood and other brokerages are required to assign levels to customers before they can start trading options.
Robinhood looks at your trading experience, investment objectives, and financial situation to assess what level you can trade at. Depending on the parameters you meet, you’re given a Level 1, Level 2, or Level 3 designation.
You need to have a Level 2 designation to trade Robinhood options, and Level 2 allows you to execute long calls, long puts, covered calls, and cash-covered puts.
Level 3 traders can execute the following advanced options strategies: call credit spreads, put credit spreads, call debit spreads, put debit spreads, iron condors, calendar spreads, iron butterflies, and box spreads.
It’s worth mentioning here that Robinhood only allows for three day trades within a 5 business day trading window before you’re considered a pattern day trader. You’ll need at least $25,000 in your margin account to trade more than 3 trades in that 5-day window.
Understand the risk
Options trading has inherent risk, like any kind of market trade. Different options strategies have higher rates of risk, and we let’s look at an options trading example to understand the risks.
Long call example
A long call is pretty straightforward, and it’s betting on the fact that the strike price of the underlying value of the asset will increase by the expiration date.
For example, if you bought a long call option on stock XYZ which is trading at $40 a share with a strike price of $50, you are betting that the stock price will increase to $50 a share or more. You pay a premium for the option, and we’ll say it’s $10 for a block of 100 shares of XYZ, making the premium $10 x 100 = $1,000 premium.
The premium you pay gives you the right to buy the stock at $50 even if the price goes up. If the price of stock XYZ goes up to $60 a share, then you can exercise your option and buy the shares for $50 a piece. You can even trade your option to another investor and earn income there.
The risk comes in if the price of the underlying asset does not meet the strike price. If stock XYZ decreases to $30 a share, it doesn’t make sense to buy it for $50 a share. Your option contract gives you the ability not to buy XYZ, but you’ve still paid the premium and now you’re out $1,000.
Different types of options trades have different risks, and you need to understand your potential losses before you start trading.
Watch out for FOMO
I’m sure you’re familiar with FOMO, or Fear of Missing Out. It’s the anxious feeling that someone out there is having more fun that you. But there’s been a lot of investing FOMO recently with people on TikTok and Reddit bragging about their wild stock market returns and hot tips. It doesn’t matter if these investors have real experience or not. Other people want in on the fun and they don’t want to miss out on a stock that might go to the moon.
Because of the benefits of options trading -- flexibility, leverage, and potential higher returns -- options trading has been an exciting way for new investors to take part in the hype. In fact, option contracts have increased nearly 3x in the past 13 months according to the Options Clearing Corporation.
In December 2019, the Options Clearing Corporation cleared 227 million option contracts, and in February of 2021 they cleared over 572 million option contracts.
The reality is that random people on the internet sharing stock tips is dangerous business for brand new options traders. Okay, it’s risky for types of investors. FOMO investing can be incredibly speculative, and you run the risk of losing a lot money.
My point is to avoid the online hype as much as possible because FOMO trading is more gambling than investing. If it’s something you’re really interested in doing, then set a budget for it -- don’t let it be your entire portfolio.
How to trade options on Robinhood in 5 steps
Now you’re ready to actually start trading options on Robinhood. You understand key terminology, the risk, and you’re going to stay away from FOMO investments as much as possible.
Starting to trade options on Robinhood is fairly straightforward, and you can do it from the Robinhood app or on the desktop version.
If you don’t have a Robinhood account yet, you’ll need to set on up first. Click here to set up your free Robinhood trading account. You’ll be asked basic financial advice, and Robinhood will ask about your trading experience, finances, and objectives to assign you a trading tier before you can start trading options. Your assigned tier tells you what kinds of options trades you can execute.
Once your account is set up, here are the specific steps to place an options trade in the Robinhood app:
- Tap the magnifying glass icon in the top right hand corner of your home page
- Search the name or ticker symbol of the stock you want to trade options for
- Tap on the name of the stock you want to trade
- Tap “Trade” in the bottom right hand corner of the stock’s info page
- Tap “Trade Options”
Robinhood lists different strike prices, expiration dates, and premiums in the app. You’ll need to select those, and whether or not you want to place a Good-til-Canceled order (order remains open for 90 days) or a Good-for-Day order (canceled at market close that day if it doesn’t execute).
The final word on buying options on Robinhood
There can be serious benefits to options if you play it smart and focus on the long-term. They add leverage in your portfolio because there’s the potential to control more shares than you could afford to own if you had to buy them directly.
Options trading has it’s downsides when you’re chasing short-term bets or lack the experience and knowledge to execute complex trades.
Because it’s commission free and has $0 contract fees, Robinhood’s user friendly app is a great place to learn how to start trading options. It still lacks some of the most complex types of options trades, so when you’re ready to flex your abilities, research your options thoroughly and keep playing it smart.