A basic introduction to options trading

What is an option - everything you need to know

Key points about options trading:

• An option is a financial contract that gives you the right, but not the obligation, to buy or sell an asset at a predetermined price.
• The majority of income from options trading comes from trading the contracts themselves, not from exercising them on the underlying asset.
• American options offer greater flexibility as they can be exercised at any time before the expiration date, while European options can only be exercised at expiration.
• Mastering premium, strike price, expiration date, and other key concepts is crucial for successful options trading.

How options trading works in practice

Options trading is essentially about buying and selling options contracts. Unlike direct stock trading, an option gives you the ability to secure your decisions without immediate obligation.

Imagine you are interested in buying a home but want to wait and see how the market develops. You could negotiate an option with the seller - an agreement that ensures you can buy at a certain price during a specific period, but without being obligated to do so. For this right, you pay a rent, called a premium.

If the property price increases, you can choose to buy at the agreed price and profit from the difference. If the price falls, you can simply walk away and only lose the premium. Or - and this is essential - you can sell the option itself to someone else before the time expires, if its value has risen. In this way, you are trading the right to buy, not the property itself.

This is the precision behind options trading: you speculate on the value of the contract, not necessarily on the underlying asset.

What is an option really?

An option is a binding contract that gives the holder the right to buy or sell a specific asset at a predetermined price - called the strike price - on or before a certain date, the expiration date.

The critical word here is “right”. You are never obligated to do anything. You can choose to exercise your right or let the contract expire worthless.

The value of an option changes constantly. It is not locked in. Factors such as the market price of the underlying asset, the remaining time until expiration, and general demand affect how much the option is worth. If the market moves in your favor, your option can become more valuable, giving you the chance to sell it for a profit.

Call options - the right to buy

A call option gives you the right to buy an underlying asset at the strike price before or on the expiration date. Traders buy call options when they expect the price of an asset to rise.

If you are right - and the price goes up - you can either:

1. Buy the asset at the low strike price and sell it at the higher market price for immediate profit
2. Sell the options contract yourself before expiration, when its value has increased.

Most options traders choose the second option: to sell the contract for profit rather than actually buying and selling the asset.

Put options - the right to sell

A put option is the opposite. It gives you the right to sell an asset at the strike price on or before the expiration date. You buy put options when you believe that a price will fall.

If the market moves downside, you can sell your asset at the higher strike price, even if the market price has fallen. The longer the price falls below the strike price, the more valuable your option becomes. You can then sell the options contract itself to another trader for profit.

Which assets can you trade options on?

The options market is broad. You can find options on:

• Cryptocurrencies: Bitcoin (BTC), Ethereum (ETH), BNB, Tether (USDT) and many others
• Stocks: Apple (AAPL), Microsoft (MSFT), Amazon (AMZN) and other publicly traded companies
• Index: S&P 500, Nasdaq 100 and other market indices
• Commodities: Gold, oil, natural gas, and other physical resources

The Critical Components of an Options Contract

Expiration Date

The expiration date is the “deadline” for your options contract. After this date, the contract is dead - it can no longer be exercised or traded. Different options have different expiration dates, ranging from weeks to months or even years.

The strike price

The strike price is the predetermined price at which you have the right to buy ( in a call option) or sell ( in a put option) the underlying asset. This price never changes during the life of the contract.

The relationship between the strike price and the current market price directly determines how much your option is worth. If the market price rises far above the strike price ( for a call option), the option becomes very valuable.

The Prize

The premium is simply the price you pay for the options contract - the cost of the right to buy or sell without the obligation to do so.

Several factors influence the size of the premium:

• The current market price of the asset
• How volatile ( the asset's price is
• How far the strike price is from the current price
• How much time is left until the expiration date

Higher volatility generally increases the premium, as there is a greater likelihood of larger price movements.

) Contract size

Typically, a stock options contract represents 100 shares. However, for index or cryptocurrency options, the contract size can vary significantly. It is always important to check this detail before trading.

Trying to understand the value of money

When traders talk about “in the money” ###ITM(, “at the money” )ATM( and “out of the money” )OTM(, they describe the relationship between the strike price and the current market price.

For call options:

• ITM: The market price is higher than the strike price ) the option is profitable (
• ATM: The market price is approximately equal to the strike price
• OTM: The market price is lower than the strike price ) the option is not profitable yet (

For put options:

• ITM: The market price is lower than the strike price
• ATM: The market price is approximately equal to the strike price.
• OTM: The market price is higher than the strike price

These terms affect not only whether an option is worth exercising but, even more importantly, how much the contract itself is worth on the market.

The Greeks - Risk Measures for Options Traders

In options trading, professional traders use something called “the Greeks” - mathematical measures that show how different factors affect an option's price.

Delta )Δ( measures how much an option's price changes when the underlying asset's price changes by 1 dollar.

Gamma )Γ( measures how quickly delta itself changes, providing a sense of the contract's acceleration.

Theta )θ( represents time decay - how much value an option loses as the expiration date approaches. This is a counteracting force for option sellers.

Vega )ν( shows how sensitive the option is to market volatility. Higher volatility usually increases option prices.

Rho )ρ( measures the sensitivity to interest rate changes, although this is less important for most traders.

By understanding these measures, traders can better assess risk and make more informed decisions.

American versus European Options

There are two main types of options based on when they can be exercised:

American options can be exercised at any time before the expiration date. This gives the holder much greater flexibility and is generally more expensive than the equivalent European option.

European options can only be exercised exactly on the expiration date, not before. They are usually cheaper but offer less flexibility.

It is worth noting that these names have nothing to do with where the options are traded - both types exist on markets worldwide.

Conclusions on Options Trading

An option is at its core a tool for flexibility. It allows you to gain exposure to an asset's price movement without immediate commitment. You can take a position without actually owning the asset.

The core of modern options trading is not to exercise the options - it is to trade the contracts themselves and profit from how their value changes.

Before you start trading options, it is absolutely critical to understand these fundamental concepts: expiration date, strike price, premium, and how these create the value of an options contract. Options trading offers great opportunities but also requires solid knowledge to effectively manage the risks.

Learn more about advanced strategies and risk management before making your first trades.