Options are a very useful trading and investment tool, especially when the market is volatile. It plays a role in micromanaging, hedging stocks, and enhancing potential returns. But it is more complex relative to stocks, leading many newcomers to the idea of giving up when understanding the basics of options.
To help you understand options and learn how to trade options, we have organized the essential knowledge of stock options trading into this article. The full text will be a bit longer, but it is recommended that you familiarize yourself with this knowledge before trading options.
What are options
An option is a contract between a buyer and a seller.
Simply put: The buyer gives the seller a sum of money, and in exchange, the buyer acquires the right to buy or sell the asset of the option contract at the agreed price on or before the specified date. The seller receives a sum of money from the buyer, but may be required to assume responsibility for buying or selling the asset at the agreed price on or before the specified date.
5 Key Elements of Options
Each option contract contains five important factors: the asset of the contract, the type of option, the price of the option, the option price, the option amount, and the expiration date.
This information needs to be carefully verified before each option trade.
Contract Standard Assets
An option contract refers to an asset that is traded between the two parties, including stocks, indices, foreign exchange, commodities, etc., when exercising an option.
Option Type
Options are divided into Call and Put. The bullish option gives the buyer the right to buy the contract mark, while the bearish option gives the buyer the right to sell the contract mark.
Line option price
The price of the asset for which the two parties have agreed to trade the relevant standard.
Option Money
The price of the options contract in the market, the cost paid by the option buyer direction option seller.
Expiration Date
The date on which the options contract expires. If the option buyer does not exercise before the expiration date, he will lose the option funds. Of course, buying or selling options does not mean that you have to wait for the option to expire, you can choose to close the position before the expiration date, take profit or stop loss early.
The options are divided into US options and European options: holders of US options can exercise on the date or any day before, and holders of European options can only exercise on the current date. You can view the option types on the tool options page in Futubull.
For example, this option in the screenshot is a bear option (Put) marked by Apple (AAPL), with an expiration date of April 19, 2024, a bond price of 177.50 and an option price of 4.40.
Extended Reading:【Keep these 5 key points in mind when trading options】
4 Basic Strategies of Options/Sing-Leg Option
Since the option types are divided into Call and Put, plus the trading direction of buying and selling, four basic strategies (also known as one-legged or one-sided strategies) can be formed:
Buy Bullish Options (Long Call)
Sell/Sell Short Call
Buy Bearish Options (Long Put)
Sell/Sell Bearish Options (Short Put)
We can clearly see the corresponding rights or obligations to buy and sell options, as well as the applicable scenarios for the 4 strategies:
Extended Reading:【4 Options Basic Strategies】
The basic concepts section is explained here, and the following sections will cover the stock options that interest you most, introduce the necessary knowledge and trading strategies in real life.
If you want the system to learn more options introductory courses, you can click on the following link to watch the tutorial video for free:Futures Beginner Tutorial
Factors Affecting Option Pricing
Option money is a crucial factor, whether for hedging risk or for earning spreads.
For option buyers, option money is the cost that needs to be paid; for option sellers, option money is the maximum profit that can be obtained at the moment.
Usually, when we look at the future price movement of a stock, we can choose to buy a Call, and if we look at the future price movement of a stock, we can choose to buy a Bear option (Put). But in practice, there is often a rise in positive stock prices, but the price of the Call option does not go up. Why?
This requires an understanding of the influence of the option price (option gold). The option price consists of intrinsic value and time value.
Intrinsic Value
The high and low of the value of the option is related to the average stock price yield. Simply put, after buying a Call, if a bullish movement occurs in the price of the benchmark stock, the intrinsic value of the Call will also increase; conversely, if the positive stock price shows a downward movement, the intrinsic value of the Call will decrease.
The relationship between the option bank option price and the share price of the common stock is divided into three types:
In-the-Money Option: A Call option with a warrant price below the current price of the positive stock, or a Put option with a price higher than the stock price;
Out-of-the-Money Option: A Call option with a warrant price higher than the current price of the positive stock, or a “Put” option with a price lower than the stock price;
At-the-Money Option: An option with an option equal to the stock price of the common stock.
If you hold an option, the option can only be exercised when it is within the price. Therefore, the price of off-price options is usually lower than that of in-price options, and the potential risks and returns are relatively higher.
Option Chains are usually used when we are doing practical manipulation. Option Chain is a feature that filters options based on option type, expiration date, line price. Through the option chain, we can clearly see the variation in the option price corresponding to the price of the different bank options.
>> The design images displayed on the screen are for illustrative purposes only and do not constitute any investment advice or guarantee.
As shown in the figure, on the left is the Call option and on the right is the Put option. The middle black bar indicates the current price of the positive stock of the mark.
The options in the blue shadow area in the figure belong to the In-the-Money Option, while the rest belong to the Out-the-Money Option. We can clearly see options price changes.
Time Value
The time value is affected by the residual value before the expiration of the option contract. If you are a buyer of an option, it is important to note that the time value of the option is gradually lost as the expiration date approaches. Assume that after buying options, the price of the benchmark shares remains unchanged, but over time, the option price will gradually decrease.
>> The design images displayed on the screen are for illustrative purposes only and do not constitute any investment advice or guarantee.
In the Options Chain, we can clearly see that both in-price and off-price options, for example, the lower the price of options closer to the expiration date.
In addition, it should be noted that the closer the maturity date, the greater the volatility of the option price, the higher the relative risk. Options that expire on the same day are known as “expiration options”. These options are highly sensitive to changes in the price of the main stock market and are often subject to sharp ups and downs, and the risk is high.
If you are new and have a lower risk preference, you can choose options with a slightly earlier maturity date, such as those within 1~3 months.
In addition to this, there are some other factors that affect the price of options, such as pullback volatility, etc. If you want to know more you can read the following:Option Price Formulas
How to Trade Stock Options
If you are a beginner, you can start by choosing a stock option.
For example, if you want to trade Apple (AAPL) options, you can search for apples in the Futubull App or AAPL, select the Term Permissions column in the bottom left corner and enter the Term Permissions link page.
In the options chain, select the expiry date and line option price separately, and double click on the specific option to enter the quotation page of the option to trade.
>> The design images displayed on the screen are for illustrative purposes only and do not constitute any investment advice or guarantee.
How to Trade Options with Futu
1. Before trading options, you need to open a securities account first. Limited time option for new customers to get a $4200 discount reward, click below to claim now
2. If you want to learn more about the detailed steps, analysis features, and precautions for trading US stocks, you can learn it in the free course below:Introductory Teaching of Securities
Extended Reading:US Stock Option Fees,Hong Kong Stock Option Fees,Futu Options Services
Common Options Strategies
In addition to the 4 basic strategies, different line options or options in different directions can combine more complex strategies to match different trading objectives.
Stock Guarantee Strategy Covered Call
Covered Call is a strategy made up of a combination of holding stocks and options. This strategy is suitable for holding stocks, but anticipating short-term stock price declines, hoping for a scenario where risk is hedged through options.
For example, suppose Judy holds 100 shares of A stock, but anticipates that there may be some volatility in the near future, and if she wants to hedge the risk of a drop in the stock price with a Covered Call strategy, she can do this:
In the Futubull app, enter the stock trading details page, click left on the options section below to enter the options link.
Select the Bullish direction; choose an expiration date, such as April 5; and choose a line option price, such as 530.
Click on the corresponding option, a pop-up window will appear at the bottom of the page, select the trade direction “Sell”, pay attention to the option's profit and loss balance point, etc.; click “Trade”.
Set the selling price and quantity (if you hold 100 shares, up to 1 option can be sold accordingly).
As shown in the illustration, if Judy sells one option with a price of 6.05 on the same day and sells 1 option maturing on April 5 with a line option priced at $530, you can earn $605 immediately after the order is placed.
If the A share price rises above $530 before the option expiration date, the option buyer may request an exercise, and Judy will need to assume the obligation to sell the preferred shares and sell 100 shares of A stock at a $530 warrant price. But relatively speaking, a rise in stock prices can also bring positive returns for Judy.
If the stock price does not rise above $530, Judy can earn a steady $605 option fund, to some extent countering the risk of a fall in the stock price of the holding.
Extended Reading:【Do you earn pennies on the stock market? 【Option strategy insurance is profitable]
You can also click on the link below to learn more about this strategy:【Earn Extra Income with Stock Guarantee Strategies】
Sell Bearish Options Short Put
How do well-known investors use options strategies? Many people will recall the classic case of Buffet the “God of Might”:
BUFFETT HAS BEEN BUYING COCA-COLA SINCE 1988. In April 1993, he considered Coca-Cola's stock price to be too high and sold a Coca-Cola Bear (Put) option, which expired on December 27, at $35 million. After selling the options, Buffett immediately received $750 million in options.
In this scenario, if Coke breaks above $35 before the option expiration date, Buffett's sold option becomes an In-the-Money Option, where he can buy a lot of stocks at a lower price. Conversely, if the Coca-Cola share price does not fall below $35, the option is an Out-of-the-Money Option, which the option buyer does not exercise, so Buffett can earn $750 million in royalties after the option is sold.
Whether it's buying stocks at low prices or earning royalties, this seemingly win-win strategy is called Short Put. This strategy is applicable not only to institutions, but also to ordinary investors.
The Short Put strategy is used to sell a bearish option at a recognised fair price at a recognised fair price, with a view to the company's development over the long term, with the expectation of continued stocking at a lower price. If the option to sell without holding a positive stock is the Naked short option, the risk is relatively higher and the margin requirement will be higher.
You can click the link below for more specific scenarios and content about this strategy:【Do you want to fish before the explosion of the heart water? Try the Short Put used by Buffet】
Buy Saddle Set Long Straddle
A classic Long Straddle strategy can be used if a major event is to happen next that affects the entire stock market or a particular stock, but it is difficult to predict the direction of the market or stock price after the event. Executing this strategy requires buying the same two benchmark stocks, the same line option price, Call and Put option on the same maturity date.
If Jerry predicts that Tesla will publish a big news in the near future, if the news is expected to create a big wave in the stock price in the short term, and if the share price will rise, it will be possible to quickly create a Long Straddle combination using Futubull's compositional strategy function:
Enter Tesla's options chain and select the strategy “Saddle Combination” at the bottom of the page.
Choose a maturity date, such as April 19; select a peer option price, such as 177.5; select “Buy” for the trading direction.
Drag up the bottom popup to view the profit and loss balance points and the options combination's profit and loss chart after buying this combination.
Click Trade to buy both the selected bullish and bearish options at the same time.
>> The design images displayed on the screen are for illustrative purposes only and do not constitute any investment advice or guarantee.
Based on the profit and loss balance point and the profit and loss chart, we can see that Jerry's option combination order is profitable before the option expiration date, when the stock price is above 198.5 or below 156.5; but if the stock price is between 156.5~198.5, this combination generates losses. The maximum loss is expected to be $2078 at the cost of buying the combination.
If you want to know more about this strategy, you can click on the link below:Buying Saddle Combination Benefits
To learn more about Options Advanced Combination Strategies, click the following free course to learn:Advanced Portfolio Options Strategy
Practical Tip: Estimate Stock Price Volatility by Expecting Options
During the financial season, the stock market usually has large volatility, which can provide traders with potential trading opportunities. But how do we know the extent to which a stock rises or falls after a report? Investors or traders can make financial predictions using a tool called Expected Volatility.
Expected move refers to the future rise and fall of a stock based on the current option price.
By understanding expected volatility, investors or traders can spy on the options market to predict price changes for a particular stock or ETF over a period of time. This can help traders identify potential trading opportunities and manage risk, especially during major events such as financial reports, macroeconomic indicator releases or FDA announcements.
The easiest way to calculate expected volatility is to multiply the price of an equal Long Straddle (saddle option combination) by 85%.
Simply put, to calculate the expected volatility of a stock during the reporting week, you can try the following steps:
Select the first option expiration date after the company publishes the report.
Find the option chain and add the price of the medium bullish option to the price of the medium bearish option to get the price of the saddle option combination.
Then multiply that value by 85% and you get the expected volatility, which is the extent to which stocks can fluctuate. You can also divide the results by the current price of the stock to get the percentage of the expected volatility of the stock.
But it is worth noting that the calculation of expected volatility is only the expected volatility of the stock price, and the direction is uncertain. That is, the share price may rise or fall.
Extended Reading:【Will the stock price rise after the results? A formula to help you calculate the rise and fall]
