Options are financial derivatives that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined strike price before or at expiration, in exchange for paying a premium. Options are classified into two fundamental types: Call options (bullish) and Put options (bearish), each serving multiple trading and hedging purposes.
Key Characteristics of Options
1. Leverage
Options allow controlling a large asset position with a relatively small premium. For instance, controlling HKD 1,000,000 worth of stock through call options may cost only HKD 50,000-100,000 in premium. Leverage amplifies both gains and losses.
2. Asymmetric Risk-Reward
Buyers have limited downside (maximum loss = premium paid) with theoretically unlimited upside. Sellers have the opposite profile: limited upside (max gain = premium received) with potentially unlimited downside.
3. Time Decay (Theta)
Options have time value that decays exponentially as expiration approaches. At expiration, options retain only intrinsic value. This time decay benefits option sellers and is the core mechanism behind income-generating strategies.
Common Option Strategies
- Covered Call: Hold underlying stock while selling calls to generate premium income
- Protective Put: Hold stock while buying puts as insurance against downside
- Straddle: Simultaneously buy call and put at same strike to profit from large price swings
- Butterfly Spread: Three-strike strategy for limited risk and limited profit potential
- Iron Condor: Four-strike neutral strategy profiting from low volatility environments