Options Basics
On this page you will find educational information about options and video tutorials for mastering options trading fast. Enjoy fixed prices and unlimited upside of the options contracts.
What are Options?
An option is a contract giving the buyer the right, but not the obligation, to buy (in the case of a call option contract) or sell (in the case of a put option contract) the underlying asset at a specific price on or before a certain date. Traders can use on-chain options for speculation or to hedge their positions. Options are known as derivatives because they derive their value from an underlying asset.
Video: Call and Put Options
What is a Call Option?
A call option is an option contract giving the owner the right, but not the obligation, to buy a specified amount of an underlying asset at a specified price within a certain time. The pre-determined price the call option buyer can buy at is called the strike price.
For example, a single call option contract may give a holder the right to buy 1 ETH at $200 up until the expiry date in four weeks. There are many expiration dates and strike prices for traders to choose from.
Potential Profit: Unlimited as the level of the underlying asset increases
Potential Loss: Limited to premium paid for a call option contract
Example: Buying a Call Option
The price of a call option is called the premium. It is the price paid for the rights that the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid. This is the maximum loss.
If the underlying's price is above the strike price at expiry, the profit is the current asset price minus the strike price and the premium.
For example, if ETH is trading at $200 at expiry, the strike price is $150, and the option costs the buyer $10, the profit is $200 - ($150 + $10) = $40. If at expiry ETH is below $150, then the option buyer loses $10 for each contract they bought.
What is a Put Option?
A put is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying asset at a specified price within a certain time. The pre-determined price the put option buyer can sell at is called the strike price.
Potential Profit: Substantial and increases as the level of the underlying asset decreases to zero
Potential Loss: Limited to premium paid for a put option contract
Example: Buying a Put Option
The price of a put option is called the premium. It is the price paid for the rights that the put option provides. If at expiry the underlying asset is above the strike price, the put buyer loses the premium paid. This is the maximum loss.
If the underlying's price is below the strike price at expiry, the profit is the strike price minus the current asset price and the premium.
For example, if ETH is trading at $150 at expiry, the strike price is $200, and the option costs the buyer $10, the profit is $200 - ($150 + $10) = $40. If at expiry ETH is above $200, then the option buyer loses $10 for each contract they bought.
What is a Strike Price?
A strike price is the set price at which an option contract can be bought (call option) or sold (put option) when it is exercised. For call options, the strike price is where the asset can be bought by the option holder; for put options, the strike price is the price at which the asset can be sold. The strike price is a key variable of call and put options. For example, the buyer of an ETH call option would have the right, but not the obligation, to buy that ETH in the future at the strike price. Similarly, the buyer of an ETH put option would have the right, but not the obligation, to sell that ETH in the future at the strike price.
What is an Expiration Date?
An expiration date in options is the last day that options contracts are valid. On or before this day, options contracts holders will have already decided what to do with their expiring position. Before an option expires, its owners can choose to exercise the option, close the position to realize their profit or loss, or let the contract expire worthless. The expiration time of an options contract is the date and time when it is rendered null and void. It is more specific than the expiration date and should not be confused with the last time to execute that option.
What is an Option Premium?
An option premium is the price of an option contract. It is thus the income received by the seller (writer) of an option contract. In-the-money option premiums are composed of two factors: intrinsic and extrinsic value. Out-of-the-money options premiums consist solely of extrinsic value.
The main factors affecting an option's price are the underlying assetss' price, moneyness, useful life of the option and implied volatility. As the price of the underlying asset changes, the option premium changes. As the underlying asset's price increases, the premium of a call option increases, but the premium of a put option decreases. As the underlying asset's price decreases, the premium of a put option increases, and the opposite is true for call options.
The moneyness affects the option's premium because it indicates how far away the underlying asset price is from the specified strike price. As an option becomes further in-the-money, the option's premium normally increases. Conversely, the option premium decreases as the option becomes further out-of-the-money. For example, as an option becomes further out-of-the-money, the option premium loses intrinsic value, and the value stems primarily from the time value.
Example: Selling a Call Option
A trader would choose to sell a call option if their outlook on a specific asset was that it was going to fall, as opposed to the bullish outlook of a call buyer. The buyer of a call option pays a premium to the writer for the right to buy the underlying asset at an agreed upon price in the event that the price of the asset is above the strike price. In this case, the option seller would get to keep the premium if the price closed below the strike price.
For example, the seller of ETH call option with a strike price of $200 will receive a premium of $10 from the ETH call buyer. In the event that the market price of ETH drops below $200, the buyer will not exercise the call option and the seller's payoff will be $10. If ETH's market price rises above $200, however, the call seller is obligated to sell ETH to the call buyer at the lower strike price, since it is likely that the call buyer will exercise their option to buy ETH at $200.
Example: Selling a Put Option
A trader would choose to sell a put option if their outlook on the underlying asset was that it was going to rise, as opposed to a put buyer whose outlook is bearish. The buyer of a put option pays a premium to the writer for the right to sell the shares at an agreed upon price in the event that the price heads lower. If the price rises above the strike price, the buyer would not exercise the put option since it would be more profitable to sell at the higher price on the market.
For example, the seller of an ETH put option with a strike price of $200 will receive a $10 premium fee from an ETH put buyer. If ETH's market price is higher than the strike price of $200 by an expiration date, the put buyer will choose not to exercise their right to sell at $200 since they can sell at a higher price on the market. The buyer's maximum loss is, therefore, the premium paid of $10, which is the seller's payoff. If the market price falls below the strike price, the put seller is obligated to buy ETH from the put buyer at the higher strike price since the put buyer will exercise their right to sell at $200.
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