An option is a financial derivative that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a certain price at a specific date in the future. Options are categorized into two types of options based on their direction, call options and put options. The following section describes the concepts and characteristics of call and put options.
Call Options
Descriptions: A call option gives the option buyer the right to purchase a certain amount of an asset in the future at a certain price.
Characteristics: The option buyer expects the price of the asset to rise and locks in the right to purchase the asset in the future at a lower price by purchasing a call option.
When the price of the underlying asset is higher than the strike price, the option buyer can exercise the option at a profit and purchase the asset at the certain price, when the price of the underlying asset is lower than the strike price, the option buyer is not obliged to purchase the asset at the strike price. The profit potential of a call option is less than the profit potential of a futures contract by the amount of the premium paid due to the increased cost of the premium. The price of the underlying asset must rise enough to cover the original option premium in order for the trade to be profitable. The break-even point for a call option is when the profit a trader receives from purchasing the underlying asset at a certain price is equal to the option premium paid for the call option.
The maximum risk taken by a call option buyer is the option premium paid for the purchase of the call option. For every corresponding call option buyer, there needs to be a call option seller, and as a call option seller, they receive the option premium in return for accepting the risk of potentially having to sell a certain amount of the asset for less than the market price when the option expires. If the price keeps rising, the seller of the call option is exposed to unlimited risk.
Put Options
Descriptions: A put option gives the option buyer the right to sell a certain amount of an asset in the future at a certain price.
Characteristics: The option buyer expects the price to fall and locks in the right to sell the asset in the future at a higher price by purchasing a put option.
When the price of the underlying asset is below the strike price, the option buyer can exercise the option at a profit and sell the underlying asset at the certain price, and when the price of the underlying asset is above the strike price, the option buyer is not obligated to sell the asset. The profit potential of a put option is less than the profit potential of a futures contract in terms of the amount of premium paid due to the increased cost of the premium. The price of the underlying asset must fall enough to cover the original option premium for the trade to be profitable. The break-even point for a put option is when the profit a trader receives from selling the underlying asset at a certain strike price is equal to the premium paid for the put option.
The maximum risk that a put option buyer takes is the premium paid to buy the put option.
Similarly, each of the corresponding put option buyers needs to have a put option seller, and as a put option seller, they receive a premium in return for accepting the risk that they may need to purchase a certain amount of the asset at expiration of the option at a price higher than the market price. However, unlike a call option, the seller of a put option has limited exposure to risk, and their loss is at most the strike price minus the premium received, and as long as the decline in the futures price does not exceed the premium received from the buyer, the seller of the put option will profit.
Traders can purchase different options, option combinations to realize profits or control risk exposure according to market movements and their own trading strategies.
