About Options

Options are a very practical trading and investing tool, especially when markets are volatile. They can provide leverage, hedge existing stock positions, and enhance potential returns. But options are also more complex than stocks, which causes many beginners to feel like giving up as soon as they start learning the basic concepts. This article will help you understand options and learn how to trade them. Before you trade options, it’s a good idea to review the concepts below.

To make things easier to understand, let’s start with a simple example of what an option is.

Suppose Xiaoming wants to buy a house. The current price is 1 million, but he hears from a friend that home prices may fall. He is hesitant, but he is also worried that if prices rise, he may no longer be able to afford it. So Xiaoming signs a contract with the real estate developer, agreeing that one year later, no matter how home prices change, he can still buy the house for 1 million. Since a promise alone is not enough, Xiaoming must pay 20,000 as the option premium for this contract. There are two possible outcomes in the future:

1. One year later, the home price rises, and Xiaoming still buys the house for 1 million. The option premium is non-refundable.

2. One year later, the home price drops sharply, and Xiaoming simply gives up the contract. The 20,000 option premium is lost.

Because he can still buy at the original market price, Xiaoming comes out ahead even after losing the option premium. For Xiaoming, paying 20,000 locks in the risk of home-price fluctuations. What Xiaoming bought is a call option, and his maximum loss is the option premium mentioned above. If next year’s home price is below 1 million, he would not exercise the contract, because buying the house at market price would be the better deal.

Definition and Key Elements of an Option

An option is a contract between a buyer and a seller. Simply put, the buyer pays the seller a sum of money, and in exchange, the buyer obtains the right to buy or sell the underlying asset of the options contract at an agreed price on or before a specified date. The seller receives payment from the buyer, but may have to assume the obligation to buy or sell the underlying asset at the agreed price on or before the specified date.

Every options contract contains five important elements: the underlying asset, option type, strike price, premium, and expiration date. Before placing any options trade, you should carefully confirm all of this information.

  • Underlying asset: The underlying asset of an option is the object that both parties agree to trade if the option is exercised, including stocks, indexes, foreign exchange, commodities, and more.
  • Option type: Options are divided into two categories: call options and put options. A call option gives the buyer the right to buy the underlying asset, while a put option gives the buyer the right to sell the underlying asset.
  • Strike price: The agreed price at which the buyer and seller will trade the underlying asset.
  • Premium: The market price of the options contract and the cost paid by the option buyer to the option seller.
  • Expiration date: The date on which the options contract expires.

If the option buyer does not exercise before expiration, the premium will be lost. Of course, buying or selling an option does not mean you must wait until expiration. You can choose to close the position before the expiration date to take profits or cut losses early.

For example, the option shown below is a put option on Apple (AAPL), with an expiration date of April 19, 2024, a strike price of 177.50, and a premium of 4.40.

How to Trade

Here we’ll use the Futu Moomoo app as an example to briefly explain how to trade options. If you’re a beginner, you can start by choosing a stock as the underlying for your option trade. For example, suppose you want to trade options on Apple (AAPL). In the Futu Moomoo app, you can search for Apple or AAPL, tap “Options” in the lower left corner, and enter the “Option Chain” page. In the option chain, choose the expiration date and strike price, then double-tap a specific option to enter its quote page and place a trade.

Basic Ideas

So how is this tool called options actually used for investing? Let’s look at a few common trading approaches from a practical perspective.

4 Basic Options Strategies / Single-Leg Options

Since options come in two types—call options and put options—and trades can be either buys or sells, they combine into 4 basic strategies, also known as single-leg or directional strategies:

  • Long Call
  • Short Call
  • Long Put
  • Short Put

The chart below clearly shows the rights or obligations associated with buying and selling options, as well as the situations where each of the 4 strategies may be used:

Covered Call

A covered call is a strategy that combines a stock position with options. It is suitable for situations where you already hold a stock, expect the share price to decline in the short term, and want to use options to hedge the risk. For example, suppose Judy holds 100 shares of stock A, but expects some near-term volatility and wants to use a covered call strategy to hedge against a decline in the stock price. She can do the following:

  1. In the Moomoo app, go to the detail page for the stock position, tap “Options” in the lower left, and enter the option chain.
  2. Select the “Call” side, choose an expiration date such as “April 5,” and then choose a strike price such as $530.
  3. Tap the corresponding option. A pop-up will appear at the bottom of the page. Select the trade direction “Sell,” pay attention to information such as the breakeven point, and tap “Trade.”
  4. Set the selling price and quantity. If you hold 100 shares, you can sell up to 1 options contract.

As shown in the chart, if Judy sells 1 contract of the A option expiring on April 5 with a $530 strike price at that day’s ask price of $6.05, she can immediately receive $605 in income once the order is filled. If, before the option expires, stock A rises above the $530 strike price, the option buyer may choose to exercise, and Judy would then have the obligation to sell 100 shares of stock A at the $530 strike price. On the other hand, the stock’s rise would also generate a positive return for Judy. If the stock price does not rise above the $530 strike price, then Judy gets to keep the $605 premium, which to some extent helps offset the risk of a decline in the value of her stock position.

As shown in the chart, if Judy sells 1 contract of the A option expiring on April 5 with a $530 strike price at that day’s ask price of $6.05, she can immediately receive $605 in income once the order is filled. If, before the option expires, stock A rises above the $530 strike price, the option buyer may choose to exercise, and Judy would then have the obligation to sell 100 shares of stock A at the $530 strike price. On the other hand, the stock’s rise would also generate a positive return for Judy. If the stock price does not rise above the $530 strike price, then Judy gets to keep the $605 premium, which to some extent helps offset the risk of a decline in the value of her stock position.

Short Put

How do famous investors use options strategies? Many people immediately think of one of Warren Buffett’s classic examples:

Buffett began buying Coca-Cola in 1988. In April 1993, believing Coca-Cola’s share price was too high, he sold put options on 5,000,000 shares of Coca-Cola with a $35 strike price expiring on December 27. After selling the options, Buffett immediately received $7,500,000 in option premium.

In this example, if Coca-Cola falls below the $35 strike price before the option expiration date, then the option Buffett sold would become in the money. If the option buyer exercises, he would be able to buy a large amount of stock at a lower price. On the other hand, if Coca-Cola’s share price does not fall below $35, then the option remains out of the money, and the option buyer would not exercise. In that case, Buffett would still keep the $7,500,000 premium from selling the option. Whether he accumulates shares at a lower price or earns the premium, both outcomes are beneficial for Buffett. This seemingly win-win strategy is called a Short Put (selling a put option). This strategy is suitable not only for institutions, but also for ordinary investors. A Short Put strategy is appropriate when you already hold the underlying stock, remain bullish on the company’s long-term prospects, and hope to add to your position at a lower price by selling a put with a strike price you consider reasonable. If you sell the option without holding the underlying stock, that is considered a “naked short,” which carries relatively higher risk and also requires higher margin.

Long Straddle

If a major event is about to happen that could affect the broader stock market or a specific stock, but it is difficult to predict which direction the market or stock price will move afterward, you can use a classic strategy called a Long Straddle. To execute this strategy, you buy both a call option and a put option on the same underlying stock, with the same strike price and the same expiration date. Suppose Jerry expects Tesla to release major news soon. He believes the news will cause significant short-term volatility in the stock price, but he is unsure whether the stock will go up or down. He can use Futu NiuNiu’s multi-leg strategy feature to quickly build a Long Straddle position:

  1. Go to Tesla’s option chain and select the “Straddle” strategy at the bottom of the page.
  2. Choose an expiration date, such as “April 19”; choose a strike price, such as 177.5; and select “Buy” as the trade direction.
  3. Drag up the pop-up panel at the bottom to view the breakeven points and the P/L chart for the option strategy.
  4. Click Trade to buy the selected call and put options at the same time.

Based on the breakeven points and the P/L chart, we can see that after Jerry’s option strategy order is filled, the position will be profitable before expiration if the underlying stock rises above $198.5 or falls below $156.5. However, if the stock price stays between $156.5~$198.5, the strategy will incur a loss. The maximum estimated loss is the $2,078 cost paid to enter the position.

Comparison of Options Trading Platforms

The Futu Moomoo platform has compiled a comparison of various platforms’ options trading features.

  • Fee comparison
  • Tradable option types
  • Feature comparison

About Futu Moomoo and Other Stock Trading Platforms

Moomoo is Futu’s investment platform app launched in the United States, with Futu Inc. as its brokerage entity. It is a properly licensed U.S. securities broker and is also a member of SPIC and FINRA. In addition to commission-free stock trading, Moomoo also provides free Level 2 market depth data. My personal experience using it has been very good: it offers many professional features, has a user-friendly interface, and supports Chinese, which makes it feel more approachable.

Moomoo’s NVDA giveaway promotion has been upgraded again! Previously, you could receive up to 1 share of Nvidia (NVDA). Now, a $100 deposit earns you $20 worth of NVDA stock; a $2,000 deposit earns $50 worth of Nvidia stock; a $10,000 deposit earns $300 worth of Nvidia stock; and a $50,000 deposit can earn up to $1,000 worth of Nvidia stock. Idle cash can also earn 8.1% APY. The promotion expires on September 25! In addition, Moomoo US now fully supports cryptocurrency trading, including major coins such as Bitcoin, Ethereum, and SOL.

You can also consider other platforms for stock and options trading.

Stock Investing Basics

Below are a few commonly used U.S. stock brokerages, along with their signup bonuses.

Overview Signup Bonus Quick Take
Moomoo $1,030 in stock + 8.1% APY Professional platform, no commissions, and free Level 2 market data. Good for both beginners and advanced traders. Chinese-language customer service available. Requires SSN.
TradeUp 50 shares of NVDA + chance to win 5 more shares + 4% for three months No commissions, supports both U.S. and Hong Kong stocks, and offers WebTrading. Chinese-language customer service available. Available globally.
Webull $100 Amazon + 12 fractional shares + 1 month of Premium membership No commissions, with frequent deposit bonuses that give free stock.
BBAE Up to $650 bonus 0 commission, 0 fees; Chinese-friendly, and you can open an account without an SSN/ITIN.
Robinhood 1 free stock No commissions, with an interest-bearing cash account option. Simple interface that works well for beginners.
Interactive Brokers Up to $1,000 Broad market access. Professional, comprehensive trading platform with high interest on cash balances.
TradeStation $250 Professional trading platform with a full set of supporting tools.
Schwab Up to $1,000 Professional and easy to use. Global ATM fee rebates and $0 stock commissions.
Fidelity Brokerage Account Sign-up link Well-established brokerage with no trading fees, plus TurboTax included.
BIT (formerly Matrixport) $400 in stock Supports direct crypto deposits and withdrawals, does not participate in China CRS, and allows registration directly with an ID card.
SoFi Invest $75 for opening an account No commissions and supports Stock Bits.
WealthFront $5,000 managed free Automated investing and wealth management.
M1 Finance $10 for depositing funds No commissions, with automatic investing based on your portfolio allocation.

If you do not have an SSN/ITIN but still want to trade U.S. stocks, take a look at the brokerages/platforms below. All of them allow registration using a full set of Chinese documents, and you can sign up with just an ID card or passport. None of them participate in China CRS.

  • BBAE: Chinese-friendly; you can open an account without an SSN/ITIN.
  • BIT (formerly Matrixport): You can open an account with just an ID card, and approval can be completed within a few hours.
  • Bitget: Identity verification can be completed with an ID card/Chinese passport.