What exactly are options? An article to help you understand this most flexible investment tool

Why Are Options So Popular?

Stocks can only make money through low buy and high sell? Then you’re out. When stock prices fall and volatility increases, smart investors have long been using options—this powerful tool—to “reverse operate” and profit.

Options (also called “選擇權” in Chinese, English: Options) are essentially a contract that grants you the right—note, not the obligation—to buy or sell an asset at a predetermined price at a future point in time. You can choose to exercise or to abandon. The underlying asset of this contract can be stocks, currencies, indices, commodities, or even futures contracts.

Why invest with options? There are three main reasons:

Control large assets with small capital. You only need to pay a small margin (premium) to control an asset much larger than your margin, with obvious leverage effects.

Profit in both bullish and bearish markets. Buy Call options if bullish, buy Put options if bearish, or use sideways arbitrage strategies with options… no matter how the market moves, you can always find a suitable options strategy.

Hedging tool for risk management. Holding stocks and worried about a drop? Buy a put option for insurance; worried about a rebound when shorting? Buy a call option for protection.

6 Essential Terms You Must Know About Options Trading

Before starting trading, you need to understand the “Six Pillars” of options contracts:

Call (買權) — The buyer has the right to buy the asset at the agreed price.

Put (賣權) — The buyer has the right to sell the asset at the agreed price.

Premium (權利金) — The fee paid by the options buyer to the seller, similar to insurance premiums.

Strike Price (行使價) — The price at which the option can be exercised at expiration; fixed and unchangeable.

Expiration Date (到期日) — The deadline of the options contract; it becomes invalid after this date.

Contract Size (合約股數) — How many shares each options contract represents (for US stocks, standard is 100 shares per contract).

How to Read an Options Quote?

Beginners fear the jumble of numbers. Actually, an options quote has only 6 core elements:

1. Underlying Asset — What are you trading? (e.g., TSLA stock)

2. Trade Type — Call (bullish) or Put (bearish)

3. Strike Price — The future buy or sell price

4. Expiration Date — The date by which you must decide to exercise or abandon

5. Options Price — How much you pay to acquire this right

6. Multiplier — For US stock options, it’s 100; so, a quote of 0.01 USD × 100 = 1 USD

Example: Suppose TSLA is currently $175. You see a “June $180 strike Call” with a premium of $6.93. This means you pay $693 (6.93×100) to buy this right, allowing you to buy TSLA at $180 in the future.

Four Basic Options Trading Strategies

Options have four fundamental buy-sell combinations:

Buying Call Options — Betting on stock price rise

You pay for a “future discount coupon” that allows you to buy stock at a fixed price. The higher the stock rises, the more valuable your option becomes, since you can buy low and sell high.

Risk limit: You can only lose the premium paid.

Profit potential: Theoretically unlimited; the higher the stock rises, the more you earn.

Buying Put Options — Betting on stock price fall

Conversely, you buy a “future high-price sell coupon.” The lower the stock drops, the more profit you make, because you can sell high and buy back low.

Risk limit: Same as above, maximum loss is the premium paid.

Profit potential: Only fully realized if the stock drops to zero.

Selling Call Options — Agreeing to sell stock in the future

You receive the premium upfront but commit to selling the stock at the agreed price in the future.

Income: Immediate receipt of premium.

Risk: If the stock surges, your losses could be unlimited (especially if you don’t hold the underlying stock).

Selling Put Options — Agreeing to buy stock in the future

You receive the premium upfront but commit to buying the stock at the agreed price later. If the stock drops too much, losses can be severe.

For example, selling a $160 strike put and receiving $361 in premium. If the stock drops to zero, you would lose $15,639 (160×100 - 361).

Key insight: Selling options to collect premiums is tempting, but the risks are much higher than buying options. This is a classic “win a little, lose a lot” scenario.

How to Control Risks in Options Trading?

Options risk management boils down to four strategies:

First: Avoid Net Short Positions

Don’t sell too many options. If your strategy involves fewer bought options than sold options, you have a “net short” position, which carries high risk. The safest approach is to ensure bought contracts ≥ sold contracts, so maximum loss is predictable.

Second: Manage Capital

Don’t bet your entire wealth on a single options trade. Options can amplify gains but also losses. If your strategy involves paying premiums, be mentally prepared that this money could be lost entirely.

Third: Diversify Investments

Don’t put all your funds into options on a single stock or index. Build a diversified portfolio to reduce single-point risk.

Fourth: Set Stop-Losses

Especially important for strategies with net short positions, as losses can be unlimited. For net long or neutral positions, since maximum loss is capped, stop-losses are less critical.

Options vs Futures vs Contracts for Difference (CFD), Which to Choose?

These three tools each have their features, depending on your trading style:

Recommendation: Use options for precise hedging; for short-term profits with low volatility, CFDs or futures might be more straightforward and effective.

Summary

Options are the most flexible derivatives because they can adapt to various market conditions. With relatively small investments, you can leverage large capital, finding opportunities in bear, bull, or sideways markets—that’s why options are so attractive.

But there’s no free lunch. Trading options requires sufficient capital reserves, experience, understanding of pricing models, and broker approval. Poor risk management can turn even the best tools into losses.

No matter which tool you ultimately choose, remember: Tools are only valuable when your judgment is correct. Good research, understanding what you’re doing, and continuous learning are essential for winning.