Options 101 —Lesson1- Basics of Buying Call Option
Options are a type of financial instrument, an option contract offers the buyer the opportunity to buy or sell the underlying security at a given price (the option’s strike price).
There are two basic types of options called Call Options contract(allow the holder to buy the asset within a certain time window) and Put Options contract( options allow the holder to sell the asset within a certain time window).
Option 101 Lesson 1: Buy an Option contract
We take the BTC option contract for an example:
First, we log in a Bitcoin Options exchange and we can see there is an Option Chain, which is a list showing expiry dates of all available option contracts.
Then we can see there are Call options and Put options contracts for users to choose from, the left side are Call options, while the right side are Put options, and the Strike price of each contract is in the middle of the UI.
And we take BTC-18DEC20–17000-C Call Option Contract contract as an example:
For this call option, the underlying asset is BTC and the expiry date is Dec 18, 2020, the call owner has the right to buy BTC at the strike price of 17000 USD.
When the strike price $17500 on the call is less than the market price $17000 on the expiration date, the holder of the option can use their call option to buy the BTC at the lower strike price, which means the profit is 500 USD for 1 BTC-18DEC20–17000-C contract.
If the BTC market price is $16000 which is less than the strike price $17000, the contract becomes worthless and you can hold the options contract through the Expiration Date.
Undoubtedly, buying a call option will charge an additional fee, which is called “Option Premium”, It’s impossible to buy a call option and make a profit for free.
Let’s take another example, if the market price of BTC now is $16000, the left row of the picture above is composed of option contracts of BTC with a different strike price, all the option contract will be expired on Dec 18, 2020.
And the middle row is the option premium you need to pay for different Option contracts.
The right row shows the cost of different option contracts for buying BTC-18DEC20, which is calculated by adding the market price of BTC and the option premium.
This means you will take profit by executing an options contract only when the market price of BTC is higher than your cost.
Comparison with Strike price and the Market price
If an option contract is ITM ( In the money), Strike price is lower than the market price.
If an option contract is ATM ( At the money), Strike price is the same as the market price.
If an option contract is OTM (Out the money), Strike price is higher than the market price.
We can also find some rules through the pricing of Option Premium.
If the current price of the underlying asset is $16000
The cost of these two ITM options is lower than the market price, so you can see that the option premium is higher
The cost of the ATM option contract is a bit higher than the market price, so the option premium is lower than the previous one.
The cost of OTM option contract is higher than the market price. You will lose if you buy this call options now and then sell them immediately, so their option premiums are relatively low.
However, the uncertainty of options is very big, we can’t definitely say the market price will skyrocket compared to the exercise price before the expiration date or not.
About Call Options Contract, if the market price of the underlying asset is higher, then the option premium will also be more expensive.
There are two ways to make a profit by buying call options:
1. Hold the options contract through the Expiration Date, and your cost is lower than the market price.
2. Sell your call option contract before expiration, you can make profit as long as the option premium is higher than your cost.
Today’s article helps you understand what a call option is from a macro perspective. In the next article, we will analyze the profit and loss calculation method of call options. Stay tuned!