Quick Start Guide to Options Trading: A Complete Introduction to Understanding Options from Scratch

What Are Options? A Certificate That Gives You Market Control

Making money when stocks rise is simple—buy low, sell high. But what if the market declines or becomes highly volatile? Options (Derivative Rights) are the financial instruments that answer this question.

Essentially, an option is a contract that gives the buyer the right, but not the obligation, to buy or sell a specific asset—be it stocks, indices, commodities, or currencies—at a predetermined price at a future date. This agreed-upon price is called the strike price, and the date the contract expires is called the expiration date. The key point is, you hold a “right,” not an “obligation,” so you can choose to exercise or abandon the option.

Compared to other derivatives, the biggest advantage of options is flexibility. Whether in a bull, bear, or sideways market, options can help investors find profit opportunities, serving both speculative and hedging purposes.

Why Do Traders Choose Options?

The main reasons why options trading attracts investors worldwide are threefold:

Cost Efficiency — You only need to pay a small margin to control assets worth much more. For example, paying a few hundred dollars in option premiums can give you control over stocks worth thousands of dollars.

Market Environment Independence — No matter which way the market moves, options can help you profit. Expect a rise? Buy call options. Expect a fall? Purchase put options.

Hedging Tool — If you hold stocks but worry about a decline, buying put options can protect your portfolio.

Note: Before you start trading options, your broker must approve your account. The approval process involves submitting an options agreement, and the broker will assess your capital, trading experience, and knowledge level.

Quick Reference: Core Terms in Options Trading

Before entering the market, you must understand these basic concepts:

• Call Option: Gives the holder the right to buy the asset at a specific price
• Put Option: Gives the holder the right to sell the asset at a specific price
• Strike Price: The agreed-upon price for buying or selling the asset
• Expiration Date: The last date the option contract is valid
• Option Premium: The cost paid by the buyer to the seller for the right
• Contract Multiplier: The number of units represented by each contract (e.g., 100 shares for US stock options)

Understanding Option Quotes: Four Key Elements

An option quote typically includes the following information:

1. Underlying Asset — The asset tracked by the contract, such as a specific stock

2. Trade Type — Call (bullish) or put (bearish). Buying a call means you can purchase the asset; buying a put means you can sell the asset

3. Strike Price — The price you will use when executing the contract. Choosing the right strike price is crucial

4. Expiration Date — Defines your decision window. This date should align with your expectations of the underlying asset’s price movement. For example, if you anticipate a company’s earnings report will disappoint the market, choose an expiration date after the report release

5. Option Price and Actual Cost — The quote shows the unit price; the actual payment is this price multiplied by the contract multiplier. For US stock options, typically 100 shares per contract, so if the option price is $6.93, the total cost is $693

Four Basic Strategies in Options Trading

All options trades can be summarized into four combinations: buy or sell, combined with bullish or bearish.

Strategy 1: Buy Call Options (Long Call)

This is the simplest bullish strategy. You purchase a “coupon” that allows you to buy the stock at a fixed price in the future.

How it works:

• When the stock price rises: You buy at the strike price, then sell at the market price, earning the difference—the higher the rise, the greater the profit
• When the stock price falls: You can choose to abandon the contract, with your maximum loss limited to the premium paid

Example: Suppose Tesla (TSLA) is trading at $175. A call option with a $180 strike price costs $6.93. You pay $693 to buy this contract. If at expiration the stock rises to $195, you can buy at $180 and sell at $195, earning a $15 profit (minus the premium). Your maximum loss is limited to $693.

Strategy 2: Buy Put Options (Long Put)

This is the simplest bearish strategy. You purchase a “sell coupon” that allows you to sell the stock at a fixed price in the future.

How it works:

• When the stock price drops: You sell at the strike price, then buy back at the lower market price, earning the difference
• When the stock rises: You can abandon the contract, with losses limited to the premium paid

This strategy is especially useful for hedging. For example, if you hold a stock but worry about a decline, buying puts sets a “floor” price.

Strategy 3: Sell Call Options (Short Call)

You become the option seller, effectively selling the “buy coupon” to another party.

Risk assessment: Options are zero-sum—your loss equals the buyer’s profit. If you sell a call without owning the underlying stock (a “naked” call), and the stock price surges, your losses can be unlimited. You might be forced to buy the stock at a high price and sell it at a lower price to the buyer. It’s like “winning a sugar cube but losing the factory.”

Strategy 4: Sell Put Options (Short Put)

You sell a put, hoping the stock price remains stable or rises.

Risk features: Your maximum profit is limited to the premium received (e.g., $361). However, if the underlying stock drops sharply or goes to zero, your losses could reach thousands of dollars. For example, with a $160 strike put, if the stock falls to zero, you must buy the stock at $160 from the buyer, even if it’s worthless.

Conclusion: Selling options carries much higher risk than buying options.

How to Effectively Manage Risks in Options Trading?

The leverage of options amplifies both gains and losses. Risk management can be summarized into four principles:

Principle 1: Avoid Net Short Positions

Don’t over-sell options. A net short position means selling more contracts than buying, which can lead to unlimited losses.

For example, in a complex strategy: buy 1 call with a $180 strike, and sell 2 calls with a higher strike. This creates a net short position (-1). In such cases, you should buy additional protective options to hedge and shift to a neutral or net long position.

Principle 2: Control Trade Size

Don’t invest too large a sum. Calculate your maximum acceptable loss and determine the number of contracts accordingly. Many beginners judge trade size based on margin, which is incorrect—size should be based on actual contract value and potential losses.

Principle 3: Diversify Investments

Don’t concentrate all your funds in options of a single stock or asset. Build a balanced portfolio across different industries, asset classes, and time horizons.

Principle 4: Set Stop-Losses

For strategies involving net short positions, stop-loss orders are especially important. For net long or neutral positions, since maximum loss is known, stop-loss requirements are less strict.

Options vs Futures vs CFDs: Which Is Most Suitable?

These three derivatives each have characteristics; there’s no absolute “best,” only what fits your trading goals:

Options:

• Buyers have rights, no obligations; sellers face unlimited risk
• Moderate leverage (20–100x)
• Lower minimum trading amounts (a few hundred USD)
• Suitable for hedging and multi-strategy combinations
• Price changes are less sensitive; not ideal for capturing narrow fluctuations

Futures:

• Both parties must fulfill the contract
• Smaller leverage (10–20x)
• Higher minimum amounts (thousands of USD)
• Suitable for tracking standardized assets
• Higher entry threshold

CFDs (Contracts for Difference):

• Cash settlement based on asset price changes
• Max leverage (up to 200x)
• Very low minimum amounts (tens of USD)
• No expiration date restrictions
• Flexible two-way trading
• Costs mainly from spreads and overnight financing

Practical Advice: If you want short-term trading and to capture small price movements, CFDs are usually simpler and more direct. For more complex hedging and multi-timeframe strategies, options are superior. Some platforms offer commission-free trading and support multiple assets, which is friendly for beginners—just be sure to understand their cost structures.

Summary: Key Points of Options Trading

What are options? At its core, options are rights—allowing you to control large assets with a small amount of capital, seeking opportunities in any market environment. They serve both speculative and hedging purposes.

However, starting options trading requires broker approval, sufficient capital, practical experience, and theoretical knowledge. Sometimes, if option premiums are high, holding periods are short, or market volatility is low, futures or CFDs might be better choices.

Ultimately, successful investing depends on sound analysis and judgment. The tools are just means to execute your market view. Proper research, risk assessment, and psychological readiness are far more important than mere trading skills.