What Are Options?
Options are financial derivatives that give you the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific time period.
Key Concepts
Options Contract
An options contract represents 100 shares of the underlying stock. When you buy one option contract, you’re getting the right to control 100 shares.
Two Types of Options
- Call Options: Give you the right to BUY the underlying asset
- Put Options: Give you the right to SELL the underlying asset
Key Terms
- Strike Price: The price at which you can buy (call) or sell (put) the underlying asset
- Expiration Date: The date when the option expires and becomes worthless
- Premium: The price you pay to buy the option
- Underlying Asset: The stock, ETF, or index the option is based on
How Options Work
Buying a Call Option
When you buy a call option, you’re betting the stock price will go UP.
Example:
- Stock XYZ is trading at $50
- You buy a $52 call option expiring in 30 days for $1.00
- Cost: $1.00 × 100 shares = $100
Scenarios:
- Stock rises to $55: Your option is worth $3 ($55 - $52), profit = $200
- Stock stays at $50: Option expires worthless, loss = $100
- Stock falls to $45: Option expires worthless, loss = $100
Buying a Put Option
When you buy a put option, you’re betting the stock price will go DOWN.
Example:
- Stock XYZ is trading at $50
- You buy a $48 put option expiring in 30 days for $1.00
- Cost: $1.00 × 100 shares = $100
Scenarios:
- Stock falls to $45: Your option is worth $3 ($48 - $45), profit = $200
- Stock stays at $50: Option expires worthless, loss = $100
- Stock rises to $55: Option expires worthless, loss = $100
Options Pricing Components
Options prices consist of two components:
1. Intrinsic Value
The real value if exercised immediately:
- Call: Stock Price - Strike Price (if positive)
- Put: Strike Price - Stock Price (if positive)
2. Extrinsic Value (Time Value)
Additional value based on:
- Time until expiration
- Implied volatility
- Interest rates
- Dividends
Moneyness
Options are classified by their relationship to the current stock price:
| Status | Call Option | Put Option |
|---|---|---|
| In-the-Money (ITM) | Stock > Strike | Stock < Strike |
| At-the-Money (ATM) | Stock = Strike | Stock = Strike |
| Out-of-the-Money (OTM) | Stock < Strike | Stock > Strike |
Why Trade Options?
1. Leverage
Control more shares with less capital:
- Buying 100 shares at $50 = $5,000
- Buying 1 call option = $100-$500
2. Income Generation
Sell options to collect premium:
- Covered calls on stocks you own
- Cash-secured puts on stocks you want
3. Hedging
Protect your portfolio:
- Buy puts to protect against downside
- Buy calls to protect short positions
4. Speculation
Bet on price movements:
- Directional trades with calls/puts
- Volatility trades with straddles/strangles
Options vs. Stocks
| Aspect | Stocks | Options |
|---|---|---|
| Ownership | Own the company | Right to buy/sell |
| Expiration | No expiration | Expires on specific date |
| Capital Required | Full share price | Premium only |
| Risk | Can lose entire investment | Can lose entire premium |
| Profit Potential | Unlimited (long) | Unlimited (calls) or large (puts) |
| Time Decay | None | Loses value over time |
| Dividends | Receive dividends | No dividends |
Common Options Strategies
Basic Strategies
- Long Call: Bullish bet on stock rising
- Long Put: Bearish bet on stock falling
- Covered Call: Generate income on owned stock
- Cash-Secured Put: Get paid to buy stock
Spread Strategies
- Bull Call Spread: Limited risk bullish bet
- Bear Put Spread: Limited risk bearish bet
- Iron Condor: Profit from low volatility
- Butterfly Spread: Precise price target bet
Options Market Participants
1. Retail Traders
Individual investors trading for personal accounts
2. Institutional Investors
Hedge funds, mutual funds, pension funds
3. Market Makers
Provide liquidity by continuously quoting bid/ask prices
4. Proprietary Traders
Trade firm’s own capital for profit
Options Exchanges
Major U.S. options exchanges:
- CBOE: Chicago Board Options Exchange
- NASDAQ Options
- NYSE American Options
- ISE: International Securities Exchange
- BOX: Boston Options Exchange
Important Considerations
Risks
- Time Decay: Options lose value as expiration approaches
- Volatility Risk: Changes in volatility affect prices
- Liquidity Risk: Some options have wide bid-ask spreads
- Assignment Risk: Selling options may result in assignment
Tax Implications
- Short-term capital gains on options held < 1 year
- Different rules for index options
- Wash sale rules apply
- Consult a tax professional
Getting Started with Options
- Education First: Learn before trading
- Practice Strategies: Learn with small positions
- Start Small: Begin with basic strategies
- Risk Management: Never risk more than you can afford to lose
- Keep Learning: Markets constantly evolve
Options Terminology Glossary
| Term | Definition |
|---|---|
| Assignment | When option seller must fulfill obligation |
| Exercise | Using your right to buy/sell |
| Open Interest | Total outstanding contracts |
| Volume | Contracts traded today |
| Bid/Ask Spread | Difference between buy/sell prices |
| Greeks | Risk measurements (Delta, Gamma, Theta, Vega) |
| Implied Volatility | Market’s expectation of future volatility |
| Premium | Price of the option |
Using Optionomics for Options Trading
Our platform helps you:
- Track institutional options flow
- Identify unusual activity
- Analyze options metrics
- Get AI-powered insights
- Access historical data
Next Steps
Continue learning about options:
- Calls and Puts Explained
- Understanding Option Greeks
- Implied Volatility Guide
- Common Strategies
- Risk Management
Disclaimer: Options trading involves substantial risk and is not suitable for all investors. The information provided is for educational purposes only and should not be considered investment advice. Always consult with a qualified financial advisor before making investment decisions.
