How to Play Options? A Guide to Buying, Selling Strategies, and Risk Management

Getting Straight to the Point: What Exactly Are Options?

Options (also known as derivatives, in English Options) are a type of financial derivative with a very simple core concept—you pay a small amount of money to buy a “future trading right.” This right allows you to buy or sell assets like stocks, indices, commodities, etc., at a predetermined price on a specific date, but you are completely free to choose not to exercise it, with limited risk.

Compared to the single strategy of buying low and selling high, the beauty of options lies in being able to operate in any market condition: bull markets, bear markets, sideways oscillations, or even during periods of skyrocketing volatility, there are corresponding options strategies. Because of this, options are both a speculative tool and a risk hedging instrument.

How to Trade Options? Four Basic Trading Methods

Options trading is essentially a combination of “buy” or “sell” with “call” or “put,” resulting in four combinations.

Buying Call Options

Imagine you are optimistic about a stock’s future but don’t want to invest the full amount. Buying a call option is like purchasing a “discount shopping coupon”—you can buy the stock at a locked-in price in the future.

How to profit: The higher the stock price rises, the greater your profit. For example, when Tesla (TSLA.US) stock is at $175, you buy a call option with a strike price of $180 for $6.93. You only spend $693. Once the stock price rises to $200, you can buy at $180 and sell at the market price of $200, netting the difference.

Maximum loss: The premium paid for the option ($693). No matter how much the stock drops, your loss is limited to this amount because you can choose to abandon the right entirely.

Buying Put Options

The logic is reversed—if you are bearish on the market, buying a put option gives you the right to sell the asset at a fixed price. The lower the stock drops, the more you earn.

Similarly, your maximum loss is limited to the premium paid, so there’s no need to worry about excessive losses.

Selling Call Options

This is from the “seller” perspective. You sell a call option to a buyer and immediately receive the premium as income. But the cost is: if the stock price skyrockets, you might have to sell the stock to the buyer at a low price.

Risk warning: Selling options carries much higher risk than buying. If you do not hold the underlying stock (“naked sell”), a sharp rise in stock price can lead to theoretically unlimited losses. This is the so-called “winning small, losing big” scenario—small gains are hard to offset by large losses.

Selling Put Options

You sell a put option and earn the premium. You hope the stock price stays the same or rises, so the buyer does not exercise the option, and you keep the premium.

But if the stock price drops sharply, you might be forced to buy the stock at a higher-than-market strike price. For example, selling a put with a strike of $160, if the stock drops to zero, you could lose $15,639 (160 × 100 shares minus the received premium of $361), which far exceeds your gains.

Key Elements of Understanding an Options Contract

To start trading options, you must first understand the contract. Each options agreement contains six core elements:

1. Underlying Asset: The asset the option is based on, such as a specific stock.

2. Option Type: Call or Put.

3. Strike Price: The agreed-upon price for future execution, a core parameter.

4. Expiration Date: The last date the option is valid. When choosing expiration, consider the expected price movement cycle. For example, avoid options expiring after earnings reports if you expect volatility beforehand, to prevent being caught off guard by reversals.

5. Option Price: The cost you pay for this right, also called the “premium.”

6. Contract Multiplier: For US stocks, standard options cover 100 shares per contract, meaning the premium must be multiplied by 100 to get the actual cost. For example, an option price of $3.61 equals an actual cost of $361.

How to Trade Options Without Losing Money? Four Risk Control Tips

Risk management in options trading can be summarized into four points: avoid net short positions, control position size, diversify investments, and set stop-loss orders.

1. Avoid Net Short Positions

“Net short” means you sell more options than you buy. This exposes you to unlimited loss risk.

Example: Buying 1 call option (+1), but selling 2 call options (-2), results in a net position of -1, which is a net short position. If the stock price surges, losses can be unlimited.

Conversely, maintaining a “net long” position (more bought than sold) can automatically limit losses because the maximum loss is the premium paid.

2. Control Position Size

Don’t go all-in. Calculate the total contract value of your options strategy, not just the margin requirement. Options can amplify gains but also losses. If a contract’s total value is $16,000, assess whether you can bear the risk of losing all the premium if the contract expires worthless.

3. Diversify Investments

Don’t put all your funds into options on a single stock. Build a reasonable portfolio by spreading options across different underlying assets and sectors to reduce black swan risks.

4. Set Stop-Losses

Stop-loss is crucial for net short strategies. For net long strategies, stop-loss requirements are relatively lower because maximum loss is already defined.

Options vs Futures vs Contracts for Difference (CFD)

These three derivatives each have their advantages. If you want to capture short-term narrow fluctuations and your risk tolerance allows, futures or CFDs might be more direct. CFDs, with low barriers and high flexibility, have become popular among retail investors in recent years.

CFDs are based on spot prices, traded in both directions, with leverage controlling larger positions. Costs mainly come from spreads and overnight financing.

Quick Checklist for Trading Options

Before placing an order, ask yourself:

• ✓ What is my net position? (Number of bought contracts - number of sold contracts)
• ✓ What is the maximum loss for this trade? Can I afford it?
• ✓ Is the expiration date sufficient to cover my expected price movement cycle?
• ✓ Am I overly concentrated on a single underlying?
• ✓ Have I set exit points (stop-loss or take-profit)?

Summary

The core of trading options is understanding the rights, not obligations. Use minimal cost to leverage maximum gains, and find opportunities in any market condition—that’s the charm of options. But high flexibility comes with high complexity. Before trading officially, you need to submit an options agreement to your broker and pass a qualification assessment, which tests your funds, experience, and knowledge.

If options strategies are not straightforward enough, or if the underlying’s low volatility causes options prices to be inflated, futures or CFDs might be more practical alternatives. Regardless of the tool chosen, the most important thing is thorough market research and risk management—the tools only work when your market view is correct.