Take Your First steps with Options Trading
What are options? What are their advantages compared to other financial instruments, such as stocks or any other derivative?
Did you know that with options you can invest in different time horizons and benefit from the effect of time and volatility, as well as direction?
It is like trading with 3 dimensions.
“An Option is like milk: it expires.”
This analogy is simple and effective. It quickly shows how the time variable is a key concept in understanding the significant difference in the way this derivative is priced compared to others.
In essence, the option can be a way to partially or fully hedge the risks of a stock portfolio, or it can be a straightforward way to speculate on financial markets.
The underlying of an option can be anything: shares, bonds, stock indices, currencies, interest rates or commodities.
The first concept to learn what an option is to understand its classification. An option is a derivative contract, which means that its value derives from an underlying asset.
For simplicity, we talk here about options with stocks as underlying. If the price of a share rises or falls, the price of an option will behave accordingly.
The two significant differences between the two instruments are the concept of time and leverage.
Let’s start, for simplicity’s sake, with the second concept: LEVERAGE.
Example of Options Trading in Real Life
Suppose you buy a ticket for a play that will take place in months. The cost of the ticket is $300.
In our reservation, we can secure our seat for that evening, for a non-refundable price of $30 only. I will then be able to pay the difference at the theatre box office that same day. So I proceed to purchase and pay the reservation.
What happens on the day of the play?
I will be able to go, pay the difference of $270 right before I enter and enjoy the show.
Or, unfortunately, in the meantime, there is an unavoidable commitment on my schedule that I can’t give up. So I won’t be able to go to the theatre, losing my $30 off the reservation completely (but not the full ticket price of $300).
The option buyer has the right to exercise
| Event | Fact | Options' Jargon |
| I can go | I exercise my right to watch the show, I pay $270 and I join. | The option expires in-the-money, with intrinsic value. I exercise my right to buy the underlying security at a predetermined price (strike price). |
| I can't go | I can't go and I lose $30. | The option expires out-of-the-money, without intrinsic value. I lose 100% of the premium. I can't exercise my right to buy the underlying security. |
A small example, just to begin to understand how a call option works (which would be a right to buy).
With this simple analogy, we have explained the leverage effect.
With 30 dollars, we can control something that worth more (the entrance to the theatre, or the purchase of a share in three months).
If I want to go to the theatre, or if I want to buy a share (i.e. exercise my right), I have to pay the difference.
It simply means that with $30, I control value of $300 (leverage effect 1:10).
If I will not show up, or if I don’t want to buy the stocks by the due date, my maximum loss with be the premium paid (the ticket price), but not the full amount ($300).
Definition and Advantages of Options
From the example above, we understood that the option gives me the right to reserve something. Now let's leave the fantasy behind and get practical.
Options are derivative contracts that grant the buyer the right (but not the obligation) to buy (call) or sell (put) a financial instrument at a fixed price (strike price), by scheduled expiration date.
Let’s list some potential advantages over the more classic stock investment:
In stock trading, investors often rely on stop-loss orders to cap potential losses, but these can be triggered by short-term volatility. With options, the risk is built in: when you buy an option, the most you can lose is the premium you paid. This makes your maximum downside clear from the start, without the need to constantly set and monitor stop-loss levels.
When you purchase an option, your maximum loss is capped at the premium you paid, regardless of how far the underlying asset moves against your position. However, your profit potential remains unlimited as the underlying asset can theoretically move infinitely in your favor, creating an asymmetric risk-reward profile that's highly attractive to traders.
Options provide traders with the flexibility to profit from both rising and falling markets. Through call options, you can benefit from upward price movements, while put options allow you to profit from downward price movements, giving you directional trading opportunities regardless of market conditions.
The Options Chain
The Options Chain is a listing of all available option contracts, both calls and puts, for given security.
It shows:
- BID/ASK prices and sizes of CALLS at the left
- STRIKE PRICE in the middle
- BID/ASK prices of PUTS at the right
In this example, the Nvidia stock market price is $168.74. In the Options Chain, we can see for any strike price the selling (BID) and buying (ASK) market prices for calls and puts.
Example here with two investors:
- Jack buys 100 stocks, investing 168.74 x 100 = $16'874
- Simon buys 1 call, strike 170 at $5.70; expiration date in 24 days
Please note that an option contract controls 100 stocks (this may vary depending on the market).
Let’s have a look at 3 scenarios at the expiration date:
What is the difference between stocks and options trading?
SCENARIO | STOCKS | CALL OPTIONS |
| Nvidia's stock price rises +10% | Jack sells his stocks at $185.61 Profit $1'687 | Simon sells his call at $15.61 Profit $991 |
| Nvidia's stock price moves sideways and holds at the same price level | Profit/Loss = $0 | Loss: -$570 (the premium initially paid) |
| Nvidia's stock price falls -10% | Jack sells his stocks at $151.87 Loss -$1'687 | Loss: -$570 (the premium initially paid) |
Comparison between the same scenarios: results for investors in shares and investors in options.
…and let’s check the same results in term of return on invested capital:
You can see right away that:
- Simon needs less capital than Jack.
- Simon, having bought a call, needs the share price to go up before expiration (note the importance of the time effect).
- In the event of a fall or side market, Simon closes the transaction at a loss. However, his maximum loss is limited to the cost of the option (premium), and he would not lose too much capital if the market were to collapse further => the purchaser of the option has a potentially unlimited reward but a risk limited to the premium paid.
Important! Since the option buyer has 2 out of 3 unfavourable scenarios, some traders prefer to sell options instead of buying them. But for now, it’s too early to talk about it, and we still need to go deeper into other notions.
Options Trading Jargon
Call
The right, but not the obligation, to buy a specific number of shares of the underlying security at a defined price (strike), until the expiration date.
Put
The right, but not the obligation, to sell a specific number of shares of the underlying security at a defined price (strike), until the expiration date.
Strike price
The strike at which option holders can exercise their right.
Exercise
The process in which the buyer of an option takes, or makes, delivery of the underlying contract.
Assignment
The process by which the seller of an option is notified that the contract has been exercised.
Expiration
The time at which an option can no longer be exercised and the right expires.
The Payoff Charts
Let’s now dive into the 4 scenarios that can be obtained by buying and selling options, both call and put.
Mastering the reading of payoff charts is essential before exploring the different strategies you can build with options.
SCENARIO 1: Long Call
This chart is crucial for understanding the relationship between return and risk of an option:
- Buy call
- Stock price: 30
- Strike: 30 (ATM)
- Days to expiration: 40
- Premium: 1.20
In the graph above, we have on the X-axis the market prices of the underlying security and on the Y-axis the representation of the Profit/Loss, with the line of the 0 well highlighted.
For each price of the underlying, we would have clear evidence of how our strategy will react, in terms of Profit & Loss.
Let’s focus our attention on the orange line of the chart, which depicts the result of our strategy at maturity. For each value at the left of $30 (all prices below the chosen strike price), we will have a loss of 1.20 (the option price is the maximum risk).
Above $30, our CALL will have an intrinsic value.
“Intrinsic value is a measure of what an asset is worth. In options pricing it refers to the difference between the strike price of the chosen option and the current price of the underlying asset.”
If the stock raises to $40, the intrinsic value of the options is (40-30) = $10
If an option has intrinsic value, it is said to be in-the-money (ITM).
At expiration, its price will be $10, and the overall profit of the strategy will be (10–1.20) = $8.80
Breakeven point
The breakeven point for a call at maturity is = strike price + premium
30 + 1.20 = $31.20
It is the price where the profit/loss of the strategy is equal to zero.
SCENARIO 2: SHORT CALL
Take the chart above, look at it in the mirror and you’ll get this…
- Sell call (short naked call)
- Stock price: 30
- Strike: 30 (ATM)
- Days to expiration: 40
- Premium: 1.20
The breakeven point at maturity is = strike price + premium
30 + 1.20 = $31.20
For any price below the strike, the profit for the seller is the premium.
Above the strike price ($30), the seller has to pay what the buyer makes. So, as the buyer has a theoretically unlimited profit (the higher the share price, the more the option is worth), for the seller the risk is as much as holding a short trade on the stock. It means that the risk is potentially unlimited, which is why brokers require a holding margin for such a position.
TIP: to calculate the Profit/Loss of a short position, consider that when you sell an option, you instantly collect the value of the premium and then subtract the intrinsic value. Trade short options only if you are an expert and you understand the risks related, since the potential loss is extremely higher than the premium that can be collected.
What does the blue line represents?
The blue line represents the current payoff, in case the price movement should occur instantly without the passage of time.
In this example, we understand that if the price drops, our position would quickly turn into a profit. In the opposite case, it would be at a loss.
The distance between the blue line and the orange line (which we have defined as payoff at expiration) therefore makes us understand the time effect of the option. Let’s assume that the price of the underlying stock would move sideways and will be at $30 at the expiration day. In this case, we have cashed in the value of the premium over time. As highlighted before, the option buyer has 2 out of 3 unfavourable cases. The option seller thus has 2 out of 3 favourable scenarios at his disposal.
"Exercising an option" means acting on your right to buy (for a call) or sell (for a put) an underlying asset at a predetermined price (strike) before or on the expiration date of the options contract.
- It typically makes financial sense to exercise when the option is "in the money", meaning the strike price is favourable compared to the current market price.
- Most retail investors actually sell their options contracts rather than exercise them, since this is often more convenient and can capture additional time value.
SCENARIO 3: LONG PUT
You’ve come this far. Read all the article and then read it again. Share it with your friends. The secret to figure it all out is to fully learn the concept of option and the long call chart. And then flip the charts for the other three cases.
To understand the call sale, you have to flip the call purchase chart from top to bottom.
In order to understand put purchase, you have to reverse the call purchase chart from right to left.
Turn the mirror to the right side!
- Buy put
- Stock price: 30
- Strike: 30 (ATM)
- Days to expiration: 40
- Premium: 1.20
The breakeven point at maturity is = strike price-premium
30 - 1.20 = $28.80
At maturity, for each value above the strike, the premium is lost.
If the price is lower than the strike, the option will be ITM and will have an intrinsic value.
To calculate the profit at expiration, you have to deduct the cost of the option (premium) from the intrinsic value.
At $20 we will earn: (30 strike price - 20 current market price - 1.20 premium) = $8.80
TIP: remember that an option contract controls (both in Switzerland and in the USA) 100 shares, so always multiply this value by 100.
It means that $8.80 stands for $880.
“Put options are commonly used to protect the bullish positions in the market. Upon payment of a premium, investors can partially or fully preserve their equity, bond or ETF portfolio.”
SCENARIO 4: SHORT PUT
By inverting the put purchase chart, we obtain the payoff profile of a short put position (short naked put). In this case, the maximum profit is limited to the premium received, while potential losses increase proportionally if the stock price drops below the strike price.
As the seller of the option, time decay works in your favor, meaning the option loses value as it approaches expiration. Upon opening the position, you immediately receive the premium; however, a margin is required in your trading account to cover potential losses.
This is considered a high-risk strategy, as potential losses can be substantial if the underlying asset experiences a sharp decline.
Did you know that options traders rely on several key indicators, known as the Greeks, to measure how an option reacts to different market factors?
- Delta shows how much the option price moves when the underlying asset changes.
- Gamma indicates how quickly Delta itself can change.
- Vega measures sensitivity to Volatility in the market.
- Theta tells you how much value the option loses each day due to time decay.
- Rho reflects how interest rate changes can affect the option price.
You can add these variables, including Theta, directly to the Options Chain in the Swissquote platform. Theta’s effect becomes stronger as the option gets closer to expiration, making time decay a crucial factor for traders to monitor.
“Luck is what happens when preparation meets opportunity.”
Let’s review the 4 risk/return charts and watch them together:
What is moneyness of options?
Moneyness is a term describing the relationship between the strike price of an option and the current trading price of its underlying security.
a call (put) option whose strike price is below (above) the stock price.
an option whose strike price is roughly equal to the stock price.
a call (put) option whose strike price is above (below) the stock price.
An option is ITM when it has intrinsic value. It is OTM when it has not.
It is called ATM when its strike is closest to the current market price.
“Intrinsic value: The amount that an option is in the money. ”
Suppose the XYZ stock current market price is $30. In the table below, we see the intrinsic value of the different strikes:
An option must be worth at least its intrinsic value. The difference is called Time Value:
Option Value = Intrinsic Value + Time Value
At expiration, the Time Value of an option will be equal to zero.
Options Style: American vs European
- American-style options can be exercised at any time up to and including the expiration date. This early-exercise feature often makes them slightly more expensive than otherwise equivalent European-style options.
European-style options can only be exercised at expiration.
⚠️ The naming is misleading: the terms “American” and “European” have nothing to do with geography, but only with the exercise rules.
As a general rule:
US single-stock options are typically American-style.
Most European single-stock options (including SMI shares) and index options are European-style.
Exercise and assignment of options
Remember the definition:
Options grant the buyer the right to buy (call) or sell (put) a financial instrument.
The option buyer has the opportunity to:
- keep his option, sell it by expiration; speculating on the price difference between entry and exit;
- exercise his right to buy or sell the stocks, depending on whether they hold a call or put option. The exercise can take place at any time for American-style, or only at maturity for European-style options.
“Options buyers can exercise their right. ”
“Options sellers are assigned when an option is exercised, thus they have no control over the exercise procedure.”
Assignment
In options trading, being assigned means that the seller (writer) of an option contract is obligated to fulfill the terms of the contract because the buyer has exercised their option.
- For a call option seller: You must sell the underlying asset at the strike price.
- For a put option seller: You must buy the underlying asset at the strike price.
Assignment rules depend on the option style:
- American-style options: The buyer can exercise the option and assign you at any time before or on the expiration date.
- European-style options: Assignment only occurs if the buyer exercises the option on the expiration date, never earlier.
Have you grasped the potential of this powerful instrument?
Options can serve traders in many ways, including:
- Protect your investments from unexpected market swings
Seize opportunities by speculating on price movements
We’ve given you the key foundations, now it’s your turn to take the next step. Keep learning, keep practising and visit our dedicated options page for more knowledge and tools to grow your trading skills.
The content in this article is provided for educational purposes only. It does not constitute investment advice, financial recommendations, or promotional material.