Master the four key tips for options trading: Learn options from scratch

Why Are Options Worth Your Attention?

Options trading holds an important position in the financial markets, especially for investors looking to profit under different market conditions. Traditional stock trading methods limit your opportunities—making money only when stock prices rise. But options break through this limitation.

Options (英文為Options) are a type of financial derivative that give the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price at a future date. These assets can be stocks, currencies, indices, or commodities. Because of this flexibility, options trading has become an ideal tool for responding to bull, bear, or even volatile markets.

Whether you want to leverage large assets at low cost or seek profit opportunities during a downturn, options trading offers solutions. It is also an effective way to hedge risks—for example, you can buy put options to protect your stock holdings.

The Barriers Before Entering Options Trading

Getting started with options trading is not a matter of whim. Brokerages require you to fill out an options agreement to assess your financial strength, trading experience, and knowledge level. This is not just a formality but a measure to ensure investors understand the complexity and risks of options.

Therefore, before truly engaging in options trading, you need to have a solid understanding of the basic concepts, terminology, and risk management strategies related to options.

Six Key Elements of Understanding an Options Contract

Options are essentially contracts between buyers and sellers. To make these contracts meaningful, they must include several key clauses. Beginners need to learn how to interpret options quotes first. The following are the essential elements each options contract must specify:

1. Underlying Asset — The actual asset involved in the contract, which could be a stock or other financial instrument.

2. Type of Trade — Divided into call (buying rights) and put (selling rights). The former gives you the right to buy the asset, the latter the right to sell.

3. Strike Price — The agreed-upon price at which the option can be exercised. This price is fixed at the time of contract signing.

4. Expiration Date — The deadline by which you can choose to exercise the option. After this date, the option becomes worthless. When choosing the expiration date, consider the expected market movement timeframe. For example, if you anticipate poor earnings reports from a company, you should select options expiring after the earnings release.

5. Option Premium — Also called the option price, this is the fee paid by the buyer to the seller for the right.

6. Multiplier — US stock options are typically standardized at 100 shares per contract. The actual amount exchanged (the premium) equals the option price multiplied by this multiplier.

Four Basic Operations in Options Trading

Based on your market judgment and risk tolerance, options trading can be divided into four combinations:

Bullish Strategy: Buying Call Options

When you expect the stock price to rise, buying call options is like purchasing a discount coupon. You acquire the right to buy the stock at a fixed price in the future. If the stock price indeed rises, you can buy at the agreed lower price and sell at the higher market price, pocketing the difference. The higher the stock price goes, the more you earn.

Even if your prediction is wrong and the stock price falls, your loss is limited to the premium paid for the options. For example, suppose Tesla (TSLA.US) stock is trading at $175, with a call option priced at $6.93 and a strike price of $180. Buying one contract costs $693 (6.93×100). As long as the stock stays below $180, you won’t exercise the option, and your maximum loss is $693. But if the stock rises above $180, your profit begins to grow.

Betting on a Downtrend: Buying Put Options

When you believe the stock price will fall, buying put options gives you the right to sell the stock at a fixed price. If the price drops, you can sell at the higher agreed price and buy back at the lower market price, with the difference being your profit. The more the stock falls, the greater your gains.

Similarly, if your prediction is wrong and the stock rises, your maximum loss remains limited to the premium paid for the puts.

Selling Call Options: A High-Risk Game

Options trading is a zero-sum game—the buyer’s gain is the seller’s loss, and vice versa. When you sell call options without holding the underlying stock, risk arises.

If the stock price surges significantly, you might be forced to buy the stock at a high price and sell it to the option buyer at a lower price. This “win some, lose some” scenario can lead to heavy losses. Some traders sell options just to earn quick premiums but end up losing big when the stock price skyrockets.

Hidden Risks of Selling Put Options

When selling put options, you bet that the stock price will stay stable or rise. This allows you to keep the premium received. For example, the seller might receive up to $361 (3.61×100) in premium, but if the stock drops to zero, the seller’s loss can reach $15,639 (the strike price of $160×100 minus the premium received).

This occurs if you sell a put with a strike of $160 and the stock price falls to zero. You are forced to buy worthless shares at $160. The risk of selling puts is much higher than buying puts.

Key Strategies to Reduce Risks in Options Trading

Effective risk management determines the success or failure of options trading. The core points can be summarized into four aspects:

First, avoid net short positions

A net short position means you have sold more options than you have bought. Selling options carries higher risk because losses can be unlimited. If you employ complex multi-leg strategies, ensure that the number of bought contracts is at least equal to the sold contracts to set a maximum loss limit.

Example: You buy 1 Tesla call option (strike $180) and sell 2 higher strike calls (strikes $190 and $200). This creates a net short position, exposing you to risk. The best approach is to buy an additional call with a strike of $210 to balance the position, thus knowing your maximum potential loss.

Second, control your trading size reasonably

Don’t wager more than you can afford to lose. If your strategy involves paying premiums, be prepared that this money might be lost entirely. When options expire worthless, you bear the full loss.

When employing a strategy of selling more and buying less, base your trade size on the total contract value rather than the margin requirement, as leverage amplifies risk.

Third, diversify your investment portfolio

Avoid putting all your funds into options on a single stock, index, or commodity. Build a reasonable portfolio and diversify across different assets to spread risk.

Fourth, set stop-loss levels

Stop-loss is most critical for net short options strategies, where losses can be unlimited. For net long or neutral positions, since maximum losses are known, setting stop-loss levels is less urgent.

Choosing Between Options, Futures, and CFDs

Compared to other derivatives, options are more complex and less sensitive to small movements in the underlying asset. Therefore, if you want to capture short-term opportunities within your risk tolerance, futures or CFDs might be simpler choices.

Here is a comparison of the three tools:

Different trading platforms offer various derivatives services. For example, many US brokers provide CFD trading on stocks, which is relatively straightforward—open an account, select the underlying, choose buy or sell, and place the order.

Summary: Choosing the Right Options Trading Strategy for You

Options are versatile tools capable of handling various market environments. Mastering options gives you the potential to profit in rising, falling, or sideways markets. However, this tool requires high entry standards, including sufficient capital, extensive trading experience, and solid theoretical knowledge.

In practice, depending on market conditions and personal goals, futures or CFDs might sometimes be more direct and suitable, especially when options are overpriced or the investment horizon is short with low volatility.

Regardless of the tool chosen, remember: Tools only work when your market judgment is correct. Solid research and market analysis are always the foundation of success.