Essential Tips for Options Beginners! Learn These 6 Points Before Jumping In

The theme of this discussion is an introduction to options trading. I hope to provide a basic understanding and concepts of options in simple terms. Firstly, I recommend everyone to watch the options video course in the moomoo classroom. This article represents my personal understanding and insights. As a beginner in options trading myself, there might be some misunderstandings or errors, so please feel free to critique and point them out. Let's learn and grow together.

1. Meaning and Classification of Options:
Options refer to contracts that give the holder the right to buy or sell an asset at a fixed price on or before a specific date. Options are classified into European Options and American Options based on the exercise date, with European options being exercisable only on the expiration date or a specific date, while American options can be exercised before expiration. Most options traded in the US stock market are American options. Options are divided into call options and put options, representing two trading directions: buying and selling. When combined, they form four basic strategies:
- Long Call (LC)
- Short Call (SC)
- Long Put (LP)
- Short Put (SP)

2. Key Parameters of Options:
- Stock Price: The basis for pricing options, with option prices changing with stock price movements.
- Exercise Price: The agreed-upon price for buying or selling, such as the exercise price of $140 mentioned below.
- Expiration Date: After this date, if the option is in-the-money (for call options: stock price is higher than the exercise price; for put options: stock price is lower than the exercise price), it will automatically be exercised, resulting in buying or selling of stocks.
- Premium: Divided into intrinsic value and time value, with premium levels varying based on whether the option is at-the-money, in-the-money, or out-of-the-money. Intrinsic value increases as the exercise date approaches. You can observe that for options of the same exercise price, the premium increases as the exercise date gets farther.

- Implied Volatility: Implied volatility, or IV, can be thought of as the "PE ratio" of options, where higher values indicate more expensive options and lower values indicate cheaper options. Higher implied volatility benefits the seller, while lower implied volatility benefits the buyer. Sometimes, even if you buy a call option and the stock price rises, you might not make a profit or even incur a loss. This could be due to buying the option when the implied volatility was too high, followed by a subsequent decrease in implied volatility.

3. Simple Evaluation Method for Call Option Returns:
Suppose a stock's current price is $80, the exercise price of the call option is $100, and the expiration date is May 21. The current premium is $10. Buying 5 contracts.

You can simply calculate the potential profit on the exercise date by: (expected stock price at that time - exercise price - premium at purchase) * number of contracts * 100. For example, (150-100-10) * 5 * 100 = $20,000. If not yet expired, there would still be time value, making the premium higher. However, actual option prices are influenced by various factors such as bid-ask spreads and implied volatility.

4. Representation of Options' Rights:
- Holding a call option gives you the right to buy the stock at the exercise price before or on the expiration date. Theoretically, your profit potential is unlimited as stock prices can rise indefinitely. However, your maximum loss is limited to the premium paid if the option expires worthless.
- Selling a call option obligates you to sell the stock at the exercise price if the counterparty exercises it. If the option expires worthless, you keep the premium received. However, if you don't own the underlying stock for hedging, your risk is theoretically unlimited while your potential profit is limited to the premium received.
- Holding a put option gives you the right to sell the stock at the exercise price before or on the expiration date. If the stock price falls, you can use the put option to sell the stock at the exercise price. Alternatively, you can sell the put option for a profit, thereby hedging against a stock price decline.
- Selling a put option obligates you to buy the stock at the exercise price if the counterparty exercises it. Your maximum profit is limited to the premium received, while your maximum loss is capped at (exercise price - premium) * number of contracts * 100.

5. Options Handling Methods:
- Exercise: If the option is in-the-money at expiration, the brokerage will automatically exercise it for you. Ensure you have sufficient buying power to avoid the risk of forced liquidation or automatic sale of the option.
- Early Sale or Closing Purchase: As a buyer, if you don't want to exercise, you can sell the option early. As a seller, you can buy back the option to close your short position. It's similar to buying and selling stocks.
- Expiration: If the option is out-of-the-money at expiration, it expires worthless.
For short option positions, you receive the entire premium upfront when selling the option. However, you'll have a short position in your portfolio, subject to various handling methods discussed above. Also, for stocks with low trading volume, there may be significant spreads between bid and ask prices, making execution challenging.

6. How Beginners Can Practice:
I suggest selecting a stock you believe in (with low premiums) and buying one contract (representing 100 shares) of a call option (preferably with low premium or slightly in-the-money) to limit your maximum loss to the premium paid. Through practical experience, you can quickly learn and grow. Regardless of how much you study about options, nothing beats practical experience.