To The Moon

1. Introduction to Options: Understanding Call and Put Options

This chapter builds on what we've learned before in our options course. Before exploring today's topic, a brief recap of prior lessons is in order. Options are derivatives, meaning their value derives from the price of an underlying asset, such as a stock or ETF. In the previous session, the three fundamental elements of options were introduced: Premium, Strike Price, and Expiration Date. These components are essential, as they dictate how options function and determine their overall value.

This chapter builds on what we’ve learned before in our options course. Before exploring today's topic, a brief recap of prior lessons is in order. Options are derivatives, meaning their value derives from the price of an underlying asset, such as a stock or ETF. In the previous session, the three fundamental elements of options were introduced: Premium, Strike Price, and Expiration Date. These components are essential, as they dictate how options function and determine their overall value.

This article focuses on the two primary types of options: Call Options and Put Options. Below, each type is examined in detail, including their key components and practical examples.

Call Options: The Right to Buy

A Call Option grants the buyer the right to purchase an underlying asset at a predetermined price at a future date. This type of option is typically considered when an investor anticipates an increase in the underlying asset's price. Notably, it provides a "right," not an obligation, meaning the buyer can decide whether to exercise the option.

2. Key Components of a Long Call Option

Strike Price: The strike price represents the set price at which the underlying asset can be bought if the option is exercised.

For instance, a Call Option with a $50 strike price allows the buyer to purchase the underlying asset at $50, regardless of its market price. If the market price exceeds $50, a profit is possible; if it falls below, the buyer may opt not to exercise the option. Should the option be exercised, the final gain or loss depends on the underlying asset's price upon closing the position. However, exercising or letting the option expire worthless are not the only outcomes. Options possess value throughout their lifespan, enabling traders to buy and sell them before expiration, with profits or losses tied to changes in the premium.

Premium: The premium is the upfront cost paid to secure the right to buy the underlying asset. For example, if the premium is $2 per share and each contract covers 100 shares, the total cost is $200.

Example of a Long Call Option

Consider an underlying asset currently priced at $50, with an expectation that it will rise within three months. A Call Option is purchased with a $50 strike price and a $2 premium.

If the underlying asset's price climbs to $60 at expiration, the option can be exercised to buy the underlying asset at $50, which is then sold at the market price of $60. This yields a $10 profit per share, or $1,000 for a 100-share contract. After subtracting the $200 ($2 x 100 shares) premium, the net profit is $800. However, market fluctuations may alter the final profit depending on the sale price.

If the underlying asset's price drops to $45, exercising the option at $50 would be unprofitable, as the market price is lower. In this case, the option expires worthless, resulting in a $200 loss—the premium paid.

Long Call Options may suit traders expecting an underlying asset's price to increase. The potential profit arises if the price rises, while the maximum theoretical loss is limited to the premium paid.

Long Put Options: The Right to Sell

A Put Option provides the buyer the right to sell an underlying asset at a predetermined price at a future date. This option is often utilized when a decline in the underlying asset's price is anticipated, offering potential profit as the price falls.

3. Key Components of a Long Put Option

Strike Price: The strike price is the predetermined price at which the underlying asset can be sold if the option is exercised. For example, a Put Option with a $50 strike price allows the buyer to sell the underlying asset at $50, regardless of the market price. If the market price falls below $50, a profit is possible; if it rises above, the buyer may choose not to exercise. Should the option be exercised, the holder would sell the asset at the strike price, resulting in a short position. To close the position, they would need to buy back the shares at the prevailing market price, which introduces additional risk. Similar to Call Options, Put Options can be traded before expiration, with gains or losses based on premium fluctuations.

Premium: The premium is the cost paid to acquire the right to sell the underlying asset. For instance, a $2 premium per share equates to $200 for a 100-share contract. This amount represents the maximum loss if the option is not sold or expires worthless.

Expiration Date: Like Call Options, Put Options have an expiration date. If the option is "in the money"—where the underlying asset's price is below the strike price—it is generally exercised automatically, enabling the buyer to sell at the strike price. If the underlying asset’s price exceeds the strike price at expiration, the option expires worthless, and the premium is lost.

Example of a Long Put Option

Assume an underlying asset is priced at $50, with a belief that it will decline within three months.

A Put Option is purchased with a $50 strike price and a $2 premium.

If the underlying asset's price falls to $40, the option can be exercised to sell the underlying asset at $50, which is then repurchased at the market price of $40. This generates a $10 profit per share, or $1,000 for a 100-share contract. After deducting the $200 ($2 x 100 shares) premium, the net profit is $800, though market fluctuations may affect the outcome.

If the underlying asset's price rises to $55, selling at $50 would be illogical, as the market price is higher. The option expires worthless, limiting the loss to the $200 premium.

Long Put Options may appeal to traders anticipating an underlying asset's price drop. The maximum theoretical loss remains the premium, while potential profit grows as the price declines.

4. Conclusion

This chapter has covered the basics of Call and Put Options. To deepen understanding, investors should consider exploring these concepts using the paper trading function on the moomoo app, which provides a virtual environment for practice without risking real money. In the next session, the discussion will focus on how options can generate profit—whether through exercising them or closing positions.