How to Paper Trade Options
An option contract gives investors the right but not the obligation to buy (call options) or sell (put options) the underlying securities at a predetermined strike price on or before an expiration date. The price paid is the premium. Paper trading helps you understand the basics, learn from mistakes without losing money and get a feel for how the options market works.
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Instructions
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Prepare the trading worksheet. You can do this on paper, or you can keep an electronic record and make profit/loss calculations simpler by using a software spreadsheet application, such as Microsoft Excel.
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Set up six columns for the following: transaction date, option type (call or put), trade type, premium paid or received, commission charges and profit or loss. The trade types are buy-to-open, sell-to-close, sell-to-open and buy-to-close to open or close option contracts. You would pay or receive premiums to buy or sell contracts, respectively. The profit or loss is the difference between the premium paid and received on each transaction, minus commission charges.
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Pick a publicly listed stock for your paper trades. Choose a company that you know and review the information on its investor relations website. Get real-time option quotes from your online brokerage account or delayed quotes from free online websites, such as Yahoo! Finance's Options Center.
Options contracts are issued usually on three-month and longer expiration cycles. The quote screen should display the quotes for the available call and put option strike prices for each expiration cycle. The quotes are usually displayed in tabular format, with columns for the strike price, the options symbol, the last sale price, the price change from the previous close, the best bid price offered by buyers, the best ask price required by sellers, the number of contracts traded and the number of open contract positions.
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Record a paper buy order for a call or put option in your trading worksheet. This is known as an opening transaction. Learn the basics with simple buy-to-open and sell-to-close call and put option trades before moving on to more advanced option trades.
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Monitor the stock price and the option price for a few days. Keep track of the expiration dates for options. If the stock is trading at a price higher than the option's strike price, the option is "in the money" and the investor can make a profit. However, if the stock price is lower than the strike price, the option is "out of the money" and the investor is in a loss position.
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Close out your open positions. For open call and put options, this means entering sell-to-close orders. You can wait until the expiration date to close these positions, or do it after a rapid change in the underlying stock price.
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Calculate the profit/loss of each paper trade. For example, if you bought a call option contract for $150, sold it for $185 and paid commission charges of $10.50 on each side of the trade, then your paper profit/loss is $14 ($185 minus $150 minus $10.50 times 2).
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