Basics of Trading Options

What Is Options Trading?

Options trading is a type of investing where you buy or sell a contract—called an option—that gives you the right, but not the obligation, to buy or sell an underlying asset (like stocks, commodities, or currencies) at a specific price (the strike price) within a certain time period (before the expiration date).

There are two main types of options:

• Call Options: These give the holder the right to buy the underlying asset at the strike price* before the option expires. Traders typically purchase call options if they expect the price of the underlying asset to rise. If one typically buys stock because they believe in stock appreciation, then why do call options if a price rise is expected?
• Put Options: These give the holder the right to sell (forcing the buyer to purchase) the underlying asset at the strike price before the option expires, on the expiration date. Traders usually buy put options if they anticipate a decline in the assets’ price or to protect against a potential downside in a stock they own.

Think of an option like a concert ticket. Buying a ticket gives you the right to attend the show (or not), but you're not forced to go. If your plans change, you can skip the event—you only lose what you paid for the ticket.
In the same way, an options contract gives you the right (but not the obligation) to buy or sell an asset by a certain date. If you choose not to use it, you only lose the premium you paid, just like skipping the concert.

Why Use Options?
Options can serve several strategic purposes:

1. Hedging
   Used to protect against potential losses. For example, holding a stock while buying puts can cap downside risk. Covered calls may also lower risk.
2. Speculation
   Allows traders to bet on price movements with lower upfront costs. Potential for high returns, but riskier than owning the underlying asset.
3. Leverage
   Options give exposure to larger positions using less capital, which can amplify both gains and losses.
4. Income Generation
   Selling options, like covered calls, can produce income from option premiums.
5. Flexibility
   With countless combinations of calls and puts, traders can build strategies suited to any market condition or risk appetite.
6. Market Efficiency
   Options trading adds price transparency and reflects market expectations, helping investors make better decisions.

How It Works
To trade options:

• Identify the asset.
• Enter a contract with a set strike price, premium, and expiration date.
• As a buyer, your max loss is the premium you paid.
• Monitor the asset to decide whether to exercise your right to buy or sell.

Risks of Buying Options

• If the market doesn’t move as expected, your option may expire worthless.
• You lose the premium if the option is "out-of-the-money" at expiration.

Example:
You buy a call expecting a stock to go from $100 to $120. If it only reaches $105 and your strike is $115, the option expires worthless—you lose the premium.

Should You Buy or Sell Options?

• Buying Options: Good for beginners. Risk is limited to the premium paid, with high upside.
• Selling Options: Higher risk, especially if "naked" (uncovered). Losses can be unlimited and often require margin accounts. Best for experienced traders.

What If My Option Expires Worthless?

• Buyers: Lose the premium paid.
• Sellers: Keep the premium, with no further obligation.

Summary
Options offer leverage, income opportunities, and flexibility, but come with risks. New traders should start by learning the basics and consider paper trading (virtual accounts) before using real capital.

Key Terms

• Strike Price: Agreed price to buy/sell the asset.
• Expiration Date: When the option contract expires.
• Premium: The cost to buy the option.
• In-the-Money: Option has intrinsic value.
• Out-of-the-Money: Option has no intrinsic value and may expire worthless.