Introduction to options
Definition
According to Investopedia, an option is a contracts involve a buyer and seller, where the buyer pays a premium for the rights granted by the contract.
Types of options
Call options grant the holder the right to purchase an asset at a predetermined price within a defined period, whereas put options grant the holder the right to sell the asset at a predetermined price within a specified timeframe. Call options involve a bullish buyer and a bearish seller, while put options involve a bearish buyer and a bullish seller.
Why trade options?
Buying an option allows a trader to hold a levaraged position at a lower cost. Some investors use options to hedge against an exposure.
Key details
Strike price
The predetermined price at which the holder of an option can buy or sell the underlying asset if they choose to exercise the option. For call options, it's the price at which the holder can buy the asset, while for put options, it's the price at which the holder can sell the asset.
Expiration date
The date on which an options contract expires. After this date, the option ceases to exist, and the holder no longer has the right to exercise it. The expiration date determines the timeframe within which the option holder must decide whether to exercise the option or let it expire worthless.
Option premium
The price paid by the buyer of an option to the seller (writer) at the time of purchase. It represents the cost of acquiring the rights conveyed by the option. The premium is influenced by various factors such as the underlying asset's price, volatility, time to expiration, and prevailing market conditions.
Option size
The quantity of the underlying asset that the option contract represents. It can vary depending on the standardization of options contracts in different markets
Example
ETH is trading at $3,500 and Alice thinks the price of ETH will be at $4,000 this Friday.
Alice buys a call option of strike $4,000 and an expiration date on Friday. She pays a premium of $350 for an option size of 1 ETH. For the same amount, she would only be able to buy 0.1 ETH.
Price of ETH is $4,200 on Friday 4:30 PM GMT. Had she only bought 0.1 ETH, her profit would only be $70. Since she bought a call option, her profit will certainly be more than $70.
If the price of ETH is below $4,000 at expiration, she would have lost the $350 premium instead.
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