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What are Options?

Options are financial derivatives that derive their value from an underlying asset, such as stocks. An options contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) the underlying asset at a specified strike price on or before a certain date.

Strike Price

The price at which the underlying asset can be bought or sold.

Premium

The total cost of purchasing an option, influenced by the underlying stock's price, the strike price, and the time remaining until expiration.

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Exercise

To "exercise" an option means to utilize the right to buy (in the case of a call) or sell (in the case of a put) the underlying asset.

Options Trading Strategies

  • 1. Selling a Call (Covered Call)

    This strategy involves selling a call option on stocks you already own. It is used when you expect the stock to remain flat or rise slightly.


    Scenarios:

    Stock Below Strike Price: Option expires worthless, you keep the premium.

    Stock At Strike Price: Option is exercised, you sell the stock at the strike price and keep the premium.

    Stock Above Strike Price: Option is exercised, you might underperform if the stock rises above the strike price plus the premium.

  • 2. Selling a Put (Cash Secured Put)

    This strategy is used if you like the stock but find it too expensive. You sell a put option at your desired purchase price.


    Scenarios:

    Stock Above Strike Price: Option expires worthless, you keep the premium.

    Stock At Strike Price: Option is exercised, you buy the stock at the strike price, effectively at a discount.

    Stock Below Strike Price: You might end up owning the stock at a higher cost basis than the current market price unless you buy back the option.


  • 3. Buying a Put (Protective Put)

    A protective put involves buying a put option for stocks you own. It acts as insurance against a decline in the stock price.


    Scenarios:

    Stock Above Strike Price: The option expires worthless, and you lose the premium.

    Stock At Strike Price: The option is exercised, and you sell your stock at the strike price.

    Stock Below Strike Price: The option is exercised, and you sell your stock at a higher price than its current market value.

  • 4. Buying a Call (Long Call)

    This is a speculative strategy used when you expect a stock to rise but don't want to commit a large amount of capital.


    Scenarios:

    Stock Above Strike Price: Unless sold before expiration, the option is exercised, and you buy the stock below its market value.

    Stock At Strike Price: The option is exercised, and you buy the stock at the market value.

    Stock Below Strike Price: The option expires worthless, and you lose the premium.
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