Options: Understanding the Basics#

Options are derivative contracts that grant the right — but not the obligation — to buy or sell an asset at a set price before an expiration date. They are used to speculate, to hedge, or to generate income.

Call vs Put#

A Call grants the right to BUY the underlying asset at the exercise price (the strike). You buy a Call when you are bullish. A Put grants the right to SELL at the exercise price. You buy a Put when you are bearish. The buyer pays a premium to the seller for that right.

The Essential Terms#

• Strike (exercise price): the price at which you can buy or sell the asset
• Premium: the price of the option, paid by the buyer to the seller
• Expiration: the deadline for exercising the right
• In The Money (ITM): the option has intrinsic value (for a Call: price > strike)
• Out of The Money (OTM): the option has no intrinsic value
• At The Money (ATM): the price is close to the strike

The Greeks#

The Greeks measure how sensitive an option's price is to different variables:

• Delta (Δ): the change in the option price for a EUR 1 move in the underlying (0 to 1 for a Call, -1 to 0 for a Put)
• Gamma (Γ): the change in Delta for a EUR 1 move. Highest for ATM options close to expiration
• Theta (Θ): the daily loss of value due to the passage of time (time decay). The buyer's enemy, the seller's ally
• Vega (ν): sensitivity to implied volatility. Rises when volatility increases
• Rho (ρ): sensitivity to interest rates. Generally negligible except on long-dated options

Basic Strategies#

Covered Call: you hold the stock and sell an OTM Call to generate income (the premium). Protective Put: you hold the stock and buy a Put as insurance against a decline. These two strategies are the safest way to start with options.