Complete Guide to Options: From Basic to Advanced Options Trading Knowledge

What Are Options? Unveiling the Veil of Financial Derivatives

Options (also known as Warrants, in English Options) are a type of financial derivative that grants the holder the right (but not the obligation). In simple terms, what are options? They are contracts that give the buyer the right, on a specific future date, to buy or sell an asset at a predetermined price.

These underlying assets can be stocks, currencies, indices, commodities, or even futures contracts. Compared to other financial instruments, options offer unique flexibility—regardless of whether the market is bullish, bearish, or sideways, traders can find corresponding options strategies to seek profit opportunities. Because of this, options can serve both as speculative tools and as risk hedging instruments.

Why Trade Options? Core Advantages Explained

There are three main reasons to choose options trading:

First, high capital efficiency. Options allow traders to control large amounts of assets at low cost. You only need to pay a small margin to gain the right to buy or sell an asset at a fixed price in the future. This leverage effect is especially attractive to investors with limited capital.

Second, adaptability to changing markets. Unlike simple long strategies. If you expect the market to rise, you can buy call options; if you expect a decline, buy put options. This flexibility enables traders to operate in any market condition.

Third, effective risk hedging. Suppose you hold some stocks but worry about a short-term pullback. Buying corresponding put options can protect your position if the stock price drops, similar to purchasing insurance.

Essential Terms Before Entering: Basic Concepts of Options Trading

Before diving into what options are and how to operate them, you must understand the following core concepts:

• Call Option: Grants the buyer the right to buy the asset at the strike price or higher
• Put Option: Grants the buyer the right to sell the asset at the strike price or lower
• Premium: The fee paid by the options buyer to the seller
• Strike Price: The agreed-upon price at which the buyer can buy or sell the asset at expiration
• Expiration Date: The deadline when the options contract becomes invalid
• Contract Size: The amount of underlying asset represented by each options contract (typically 100 shares for US stocks)

How to Read an Options Contract? Practical Guide

Options are essentially agreements between two parties, containing six basic elements:

1. Underlying Asset: The specific asset involved in the contract (e.g., a particular stock or index)

2. Transaction Type: Call (buying the right to buy) or Put (buying the right to sell)

3. Strike Price: The reference price at which the transaction is executed, remaining constant during the contract period

4. Expiration Date: The last date the trader can choose to exercise the option. Choosing the right expiration date is crucial—for example, if you expect a company’s earnings report to disappoint the market, select an expiration date after the report release

5. Option Price: The amount paid by the buyer to the seller for the option

6. Multiplier: The number of underlying assets represented by each contract. For US stocks, standard is 100 shares. The actual amount paid or received is called the “Option Premium,” which equals the option price multiplied by the multiplier

Four Basic Strategies in Options Trading

Options are composed of two dimensions: the direction of the trade (buy/sell) and the type of option (call/put), resulting in four basic trading combinations:

Strategy 1: Buy Call Options

This is the most straightforward bullish strategy. Buying a call option is like obtaining a “discount voucher,” allowing you to purchase stocks at a fixed price in the future.

Profit and Loss Logic: The higher the stock price, the greater your profit. For example, if you buy Tesla (TSLA.US) call options with a strike price of $180 and a premium of $6.93 ($693 total cost), and the stock rises to $200, you can buy at $180 and sell at $200, realizing the profit difference.

Risk Control: Your maximum loss is limited to the premium paid ($693). If the stock price stays below $180, you only lose the premium, with no additional loss.

Strategy 2: Buy Put Options

This is the most straightforward bearish strategy. Buying a put option is like obtaining a “high-price sale voucher,” allowing you to sell stocks at a fixed price in the future.

Profit and Loss Logic: The lower the stock price, the greater your profit. If the stock drops to $120, you can sell at the fixed strike price and buy back at the $120 market price, capturing the profit difference.

Risk Control: The maximum loss is also limited to the premium paid. No matter how high the stock rises, your loss won’t increase.

Strategy 3: Sell Call Options

This is a more advanced options strategy. Selling a call option means you commit to selling the stock at the strike price if the buyer exercises the option.

Risk Warning: If you do not hold the underlying stock (naked sale), the risk is extremely high. If the stock surges, you may be forced to buy at a low price and sell at a high price, with unlimited losses. This is akin to the saying “Win a sugar, lose a factory”—the premium income is small, but potential losses are huge.

Strategy 4: Sell Put Options

Selling a put option means you commit to buying the stock at the strike price if the buyer exercises the option.

Profit and Loss Analysis: You can earn the maximum premium income. But if the stock crashes, losses can be significant. For example, with a strike price of $160, if the stock drops to zero, you still need to buy at $160 per contract (100 shares), with a maximum loss of $16,000, far exceeding the premium received.

Four Key Rules to Reduce Risks in Options Trading

Successful options traders follow four core risk management principles:

Principle 1: Avoid Net Short Positions

Do not excessively sell options. Selling options (creating short positions) carries much higher risk than buying, as losses can be unlimited. If constructing strategies with multiple contracts, ensure the number of bought contracts is not less than sold contracts (maintain a net long or neutral position).

For example: Buying 1x180 Call, selling 2x190 Call, and selling 1x200 Call = net short position (-1). To balance, buy 1x210 Call.

Principle 2: Control Position Size

Avoid over-leverage. If the overall strategy requires paying premiums, be prepared for the total loss of that amount. Options can amplify gains but also losses. Especially when using “more sells than buys” strategies, base the trading size on total contract value, not just margin requirements.

Principle 3: Diversify Investments

Avoid concentrating all funds in options of a single stock, index, or commodity. Build a balanced portfolio to spread risk.

Principle 4: Set Stop-Losses

For strategies involving net short positions, stop-loss is critical (due to potentially unlimited losses). For net long or neutral positions, stop-loss requirements are lower, as maximum losses are already defined.

The Differences Between Options, Futures, and Contracts for Difference (CFDs)

After understanding what options are, many traders consider: what are the advantages and disadvantages of options compared to futures and CFDs?

Compared to futures and CFDs, options are more complex and respond more slowly to changes in the underlying asset’s price. If you aim to capture short-term narrow fluctuations and your risk tolerance allows, CFDs or futures might be more suitable—especially CFDs, due to their flexibility and simplicity.

Below is a detailed comparison:

Summary: The Key to Rational Options Trading

What are options? In short, they are powerful tools to cope with volatile markets. Due to their flexibility, savvy traders can find suitable strategies regardless of market direction. However, options trading has a higher entry threshold, requiring sufficient capital, experience, and knowledge. Brokers also require applicants to fill out options agreements to assess eligibility.

In some cases, futures or CFDs may be more appropriate, especially when options prices are high or trading periods are short with low volatility. But regardless of the tool chosen, the ultimate trading outcome depends on your research quality and market judgment. Tools only work effectively when your judgment is correct—solid investment research is always the foundation of successful trading.