# Option basics

1. What are stock options?

4. Do all stocks have associated options?

5. Four basic profit and loss (P&L) calculations for option trading

## 1. What are stock options?

A stock option is a financial contract based on individual stocks that is traded on an exchange and settled by a clearing house. The contracts are divided into call options and put options.

The buyer of the call option has the right to buy the underlying stock at the strike price on or before the expiry date of the contract, and the seller of the call option is obliged to sell the underlying stock at the strike price if the option is exercised.

The buyer of a put option has the right to sell the underlying stock at the strike price on or before the expiry date of the contract, and the seller of the put option is obliged to buythe underlying stock at the strike price if the option is exercised.

## 2. What is option premium?

Option premium is the cost of an option or the price of an option transaction. The price of stock options traded on an exchange is displayed in a per-share-basis. The option seller charges premiums.

## 3. What is an option tier?

Options are classified into three tiers, which are set by HKEx to distinguish transaction fees.

Specific tier information can be found on the HKEx website: https://www.hkex.com.hk/products/listed-derivatives/single-stock/stock-options?sc_lang=en

## 4. Do all stocks have associated options?

No. The list of stock options can be viewed on the HKEx website at https://www.hkex.com.hk/Products/Listed-Derivatives/Single-Stock/Stock-Options?sc_lang=en

## 5. Four basic profit and loss (P&L) calculations for option trading

### 5.1 Long call options

The profit of buying a call option = (stock price - exercise price - option premium) * number of stocks; the maximum loss is the premium paid for the option.

Suppose a trader buys a call option at the market price of \$10, and the strike price of the option is \$90. On the expiration date, there are several possibilities:

1) If the price of the underlying stock is less than \$90, the trader will choose not to exercise. The maximum loss is the cost of the option premium paid. P&L = -\$1000;

2) If the price of the underlying stock is \$90, if the trader chooses to exercise and buy 100 shares at \$90, P&L = (stock price - exercise price - option premium) * number of shares = (90 - 90 - 10) *100 = -\$1000; if the trader chooses not to exercise, P&L = -\$1000;

3) If \$90 <price of the underlying stock <\$100 - for example, when the price of the underlying material is \$95 - the trader chooses to exercise, P&L = (stock price - exercise price - option premium) * number of shares = (95 - 90-10) *100 = -\$500

4) If \$100 <price of the underlying stock - for example, when the price of the underlying material is \$105 - the trader chooses to exercise, P&L = (stock price - exercise price - option premium) * number of shares = (105 -90-10 )*100 = \$500

### 5.2 Long put options

The profit of buying a put option = (exercise price - stock price - option premium) * number of stocks; its maximum profit is the exercise price * number of stocks - the option premium, and the maximum loss is the premium paid for the option.

### 5.3 Short call options

The loss of a short call option = (stock price - exercise price - option premium) * the number of stocks, the maximum loss may be infinite; the maximum profit of a short call option is the option premium.

### 5.4 Short put options

The loss of a short put option = (exercise price - stock price - option premium) * number of shares; the maximum profit of a short put option is the option premium.