A Complete Beginner's Guide to Option Contracts
Option contracts offer investors a unique way to participate in financial markets. Unlike traditional stock trading, options grant the buyer the right—but not the obligation—to buy or sell an underlying asset at a predetermined price within a specified time frame.
This flexibility allows investors to potentially profit from market movements while limiting downside risks. Understanding the basics of option contracts is essential for anyone looking to diversify their portfolio or navigate financial market complexities.
Understanding Option Contracts
Option contracts can cover various asset types, including:
- Stocks: Based on individual company shares.
- Indices: Linked to market benchmarks like the S&P 500.
- ETFs: Track baskets of assets traded on exchanges.
- Commodities: Include gold, oil, or agricultural products.
- Currencies: Reflect foreign exchange rate fluctuations.
- Interest Rates: Hedge against changes in borrowing costs.
👉 Explore how option contracts diversify portfolios
How Option Contracts Work
Key components of an option contract:
- Expiration Date: When the contract becomes void.
- Strike Price: Predetermined price for buying/selling the asset.
- Underlying Asset: The security tied to the option's value.
- Option Type: Call (right to buy) or Put (right to sell).
Two Types of Option Contracts
Call Options
- Buyer: Profits if the underlying asset’s price rises above the strike price. Risk is limited to the premium paid.
- Seller: Earns the premium but may face losses if the asset’s price surges.
Put Options
- Buyer: Profits if the asset’s price falls below the strike price.
- Seller: Keeps the premium but risks buying the asset above market value.
Pros and Cons of Call and Put Options
| Aspect | Pros | Cons |
|---|---|---|
| Call (Buyer) | Limited risk; high profit potential. | Loses premium if asset price stays below strike. |
| Call (Seller) | Immediate income from premiums. | Unlimited loss risk if asset price rises sharply. |
| Put (Buyer) | Profits from price declines; acts as portfolio insurance. | Premium loss if asset price remains above strike. |
| Put (Seller) | Premium income if asset price stays above strike. | Forced to buy overpriced assets if prices drop. |
👉 Learn advanced strategies for option trading
What Is an Option Premium?
The premium (market price of an option) consists of:
- Intrinsic Value: Difference between the asset’s current price and the strike price.
- Time Value: Reflects potential price changes before expiration.
Example: A call option with a $50 strike price on a stock trading at $60 has $10 intrinsic value.
How to Trade Options on moomoo
- Navigate to the stock’s "Details" page.
- Select "Options" > "Chain."
- Filter by expiration date or call/put type.
- Execute trades based on strategy.
FAQs About Option Contracts
Who creates option contracts?
Exchanges or financial institutions standardize them.
What’s the cost of an option contract?
Premiums vary by asset, strike price, and expiration.
Are options always for 100 shares?
Yes, standard contracts cover 100 shares.
Who benefits from options?
Both buyers and sellers can profit with the right strategy.
What happens at expiration?
- Out-of-the-money: Expires worthless.
- In-the-money: Automatically exercised unless specified otherwise.
Option trading involves significant risks and isn’t suitable for all investors. Always conduct thorough research or consult a financial advisor.