10-Minute Guide to Understanding Options

You've probably heard of options but you might not know exactly what they do.

Options are a versatile investment tool that can help leverage your capital efficiency. With a relatively small investment, you can tap into a wide range of potential market opportunities. The flexibility of options helps you manage risk associated with market fluctuations and, through their unique trading mechanics, they can offer the possibility of diverse income streams.

Today, we're going to explain in simple terms: What are options? What’s their basic structure? And how can you find them? If you're looking to explore options, then let’s dive in!

So, what exactly are options?

Simply put, an option is a contract that gives you the rights, but not the obligation, to buy or sell an asset at a predetermined price at a future date. That 'rights' part is key, it's not something you have to exercise; it’s entirely up to you.

Let’s use a real-life example. Imagine you're buying a house. You’re worried that the price might go up, so you pay a deposit and agree to buy the house at a set price within the next three months.

If the price goes up, you can still buy it at the lower price.

If the price goes down, you can choose to back out, and potentially lose some or all of your deposit.

The logic behind options works similarly, except instead of property, the underlying asset could be stocks, indices, or other securities.

This is one of the primary functions of options, helping you lock in prices or manage risks. But there’s much more to it than that. Options are flexible and can serve many different purposes:

For investors, options act like an umbrella. If you're worried about a market downturn, options can act as a hedge, helping to reduce potential losses and protect your portfolio during market downturns. Alternatively, they can potentially offer extra income during market fluctuations.

For traders, options are more like a toolbox. Looking to act on a short-term opportunity? They allow you to leverage a smaller investment to access greater market potential. Need to adjust your strategy? Options give you the flexibility to adjust your strategy and make better use of your capital. Just keep in mind, leverage can increase both potential gains and losses.

For businesses, options can be used to manage price risk. For instance, a company that relies on raw materials can use options to lock in prices ahead of time, ensuring stable costs and helping to protect against the adverse effects of unexpected price fluctuations.

Whether you're looking to hedge risk or take advantage of opportunities, options could be a good fit based on your experience, risk tolerance, finances, and trading goals. Let’s get started by familiarizing ourselves with the basics of options.

There are three crucial parts to know: the premium, strike price, and expiration date.

First up, the premium. Every option contract has a price, this is the ‘premium’. Essentially, the premium is the amount you pay to acquire the option. Keep in mind, in most cases, each option contract represents 100 units of the underlying asset. So, the premium is the total amount you pay for an option and it fluctuates based on various factors, including the price of the underlying asset, the time until expiration, and market volatility.

While pricing can get complex, the main takeaway here is that the premium is the cost of purchasing the option, and each contract corresponds to 100 units of the asset.

Next, let’s talk about the strike price. The strike price is the agreed price in an options contract.

Imagine you’ve put down a deposit to buy a house, agreeing to purchase it at today’s price within the next three months. Wouldn’t you need to know the price you’re committing to? That price is your strike price. Similarly, in options trading, the strike price is the agreed-upon price at which the underlying asset can be bought or sold.

The premium and the strike price are two fundamental elements of an option.

We'll dive deeper into these later but first, let’s discuss the expiration date because rights don't last forever.

As the buyer (holder) of the option, you have the right to exercise the contract within this period. If you don’t, the option expires, and you can no longer act on it."and you can no longer act on it.

Different types of options come with varying expiration dates. For example:

There are options that expire weekly, typically on Fridays.

The most common expiration type is monthly, usually on the third Friday of each month.

Some options have quarterly expiration dates, often seen in index options, and less commonly in individual stock options.

Lastly, there are LEAPS (Long-Term Equity Anticipation Securities), which have expiration dates that can last for a year or even longer.

Now that we've covered the basic components, let’s take a quick look at rights and obligations in options.

To buy an option, there must be someone willing to sell it to you. In other words, the options market relies not only on buyers but also on sellers. Sellers play a crucial role because without them, buyers wouldn’t have the option to purchase.

What are option sellers obligated to do? When a buyer decides to exercise the option, the seller must fulfill their obligations. This means that the seller is required to complete the trade at the agreed terms, either at the time of expiration or any time before if the buyer decides to exercise the option early.

It’s like the example we used with the house: If you decide to exercise the option and buy the house, the seller must sell it to you at the agreed price. The seller’s obligation is to be ready to fulfill the contract w   henever the buyer exercises their right.

In simple terms, the buyer has the right to decide whether to exercise the option, while the seller is obligated to fulfill the terms of the contract if the buyer chooses to exercise.

Alright, now that we’ve covered the basics of options, you’re probably wondering: how do you actually find them on a platform? No worries! An option chain is a list of all the available options for a stock, showing things like strike prices, expiration dates, premiums, bid/ask prices, volume, and more. Let’s walk through how to find it step by step.

First, start by searching for the asset you're interested in. Think of it like going to the supermarket, you need to find the right shelf. The platform’s search bar is your ‘shelf’. Just type in the underlying name or ticker symbol, hit Enter, and you’ll be taken to its details. Yes, it’s that simple!

Next, find the option chain. There’s an 'Option' tab at the top. Click it, and you’ll enter the option chain. Here, all the options related to that asset will be displayed.

Next, let's talk about expiration dates.

As we mentioned earlier, every option has an expiration date, and here, you have complete freedom to choose! Our platform offers two display modes: 'List View' and 'Tab View.'

If you prefer a clear and straightforward layout, the List View’s got you covered. By default, the nearest expiration date will be expanded, so you can see it right away. If you want to see all the available expiration dates, just click the nearest expiration date in the top-left corner to collapse it, and the other dates will be easily viewed all at once.

If you want to locate a specific date even faster, try the Tab View. In this mode, the dates are neatly arranged like tabs at the top. You just click the corresponding tab to switch to the relevant option chain, quick and convenient.

Now, let’s look at the filter box in the top-right corner. This is our expiration date filter, and it’s very practical! You can select 'Weekly,' 'Regular,' 'Quarterly,' or simply choose 'All Expirations' to display every available date. No matter which filter you select, the date list below adjusts instantly, making it very intuitive.

Next, look at the date list on the left.

Here, you’ll find all the available expiration dates, with annotations indicating the type of expiration:

- For instance, if you see a 'W' next to a date, it indicates a weekly option, which typically expires on Fridays.

- If there’s no annotation, it means it’s a regular monthly option, usually expiring on the third Friday of each month. This is the most popular choice among investors.  

- If there’s a 'Q,' it’s a quarterly option, commonly found in index options and less frequent in individual stock options.

So! With these annotations, you can quickly understand each option’s expiration type and easily find the dates that best suit your strategy!

Next up, the strike price. As we mentioned, this is the price at which you can buy or sell the asset. On the option chain, you'll see it marked as ‘Strike’, located in the middle of the chain. By selecting different strike prices, you can see which option suits your strategy.

Finally, let’s talk about the premium!

Earlier, we learned what an option premium is. Now, let’s see how to view this information on the platform.

First, in the option chain, you’ll see the Bid and Ask prices for each option. In simple terms:

• Bid is the price buyers are willing to pay.

• Ask is the price sellers are willing to accept.

• The difference between Bid and Ask is called the spread

If you’re looking to buy an option, focus on the Ask price. If you’re looking to sell an option, keep an eye on the Bid price. This makes it easy to understand the cost of the option!

You might notice that the window shows prices on both the left and right sides—this is because options come in two types: Call options and Put options. We’ll dive deeper into the differences between these two in our next lesson, so stay tuned!

Let’s say you want to buy an option now. Simply click on the Ask price, and a window will pop up displaying the details of the option you’re preparing to purchase.

In this window, you’ll see several important details:

Expiration Date: The date when the option expires.

Strike Price: The price at which you can buy (or sell) the underlying security.

Whether you’re buying or selling the option, and whether it’s a Call or Put option.

Lastly, you can choose how many contracts you want to buy. Each option contract usually represents 100 shares of the stock, but remember, you’re buying the contract, not the stock itself. So, if you buy one contract, it represents 100 shares; buy two, and it represents 200 shares.

By following these simple steps, you can easily find the options chain for the stock you are interested in, and check out key details like expiration dates, strike prices, and premiums. Once you get the hang of these basics, your options trading will become a lot smoother!

Now that you’ve learned how to find the options chain and view key details on the platform, you’ve taken an important step in understanding options trading.

In the next lesson, we’ll take a closer look at the different types of options, Call and Put options and explore even more exciting trading strategies. So stay tuned!