Options trading offers opportunities for investors looking to diversify their portfolios, manage risk, or profit from various market conditions. While options might seem complex at first, understanding different strategies can assist with determining what's best for the investor based on their financial situation and risk appetite. There are many strategies when it comes to investing. In this article, we will focus on calls and puts and how they are used.
Before we explore these strategies, here is some terminology that will be used throughout this article.
Exercise price/strike price: The exercise price or strike price is the price at which the shares will be bought and sold if the option is exercised.
Writing/ Writer: this has the same meaning as selling/seller of an option.
Naked: this is the terminology that refers to strategies when selling an option without owning the underlying asset(call option) or holding sufficient cash to buy the underlying stock (put option). In simple terms, the option is being sold to a buyer who is willing to pay a premium price for the right, not the obligation, to buy the underlying asset at a specified price (strike price) within an expiration date. Essentially, the seller (writer) acts as the middleman without having owned the underlying asset when the options contract is formed. The naked strategy is a high-risk strategy that is used by experienced investors.
Underlying asset: this refers to the stock, bond, or commodity that is to be purchased.
Basic Strategies: Calls and Puts
Call options
There are a few ways to trade call options: buying a call or going long a call, or selling a call or going short a call.
A long call option is the standard call option in which the buyer has the right, but not the obligation, to buy a stock at a strike price on or before a specific date in the future. This is used by many traders as the advantage is that it allows the buyer to plan to purchase a stock at a specific price some time in the future. An example of this is when an investor purchases a long call option in anticipation of a company's earnings announcement, as losses are limited to premiums. So, if the company does not report positive earnings and its shares decline, the buyer of the call options contract will be limited to the loss of premium paid for the options.
On the other hand, with a short call option, the seller promises to sell their shares at a fixed strike price in the future. Sold call options are often used by owners of the underlying stock who sell calls to receive premium and are happy to sell the stock if prices rise above the strike at which the call is sold.
Buying a call
A call option gives you the right, but not the obligation, to buy a stock at a specific price (strike price) before the expiration date. Buying a call can be seen as a bullish move as investors would generally use this strategy if they are optimistic about the underlying shares.
• Ideal Scenario: Use this strategy if you expect the stock’s price to rise.
• Risk: Limited to the premium paid.
• Reward: Unlimited potential if the stock skyrockets.
Example:
Here is an example of what buying a call can look like.
Scenario: Buying a call option on Kaiser Aluminium (KALU) stock
Stock details:
• Current price of Kaiser Aluminium (KALU) stock: $70/share* • You believe the stock price will rise above $75 within a month.
Call option details:
• Strike price: $75 • Expiration date: 1 month from today • Premium (cost of the option): $2 per share (options contracts typically cover 100 shares, so total cost is $2 × 100 = $200).
Your action:
• You buy 1 call option contract on KALU stock with a $75 strike price, paying $200 in premiums.
Potential outcomes at expiration: Below are two example outcomes of buying a call option based on the example above.
The stock price rises above $75 (e.g., $80):
• You exercise your option to buy the stock at $75/share.
• Market value: $80/share
Profit per share: $80 - $75 = $5
Total profit: $5 × 100 shares = $500
Subtract the premium: $500 - $200 = $300 net profit.
The stock price stays below $75 (e.g., $70):
• The option expires worthless because buying at $75 makes no sense when the market price is $70.
• Your loss is limited to the premium you paid: $200.
Source: Tiger Trade App. *The price of KALU is correct as of 03 February 2025. Please note trading fees are not considered in the calculations above.
Buying a put
A put option gives you the right to sell a stock at a specific strike price at or before expiration. A thing to note here is that put options can become more valuable as the underlying asset's value decreases and can lose its value if the underlying asset's value increases. The potential profit when buying a put option depends on how far the stock price drops below the strike price.
• Ideal Scenario: Use this strategy if you anticipate the stock price will fall.
• Risk: Limited to the premium paid.
• Reward: Significant if the stock price drops significantly.
Example:
Using the same company KALU, here is an example of what buying a put can look like
Stock and market context:
• You believe the stock price of KALU will decrease in the near future.
• Current stock price: $70 per share*.
Put option details: • Strike price: $68.
• Expiration date: 1 month from now.
• Premium (cost of the option): $2 per share.
Action: • You buy 1 put option contract. • (1 contract = 100 shares, so your total cost = $2 × 100 = $200).
Outcomes at expiration: There are three scenarios listed below that show you the different outcomes of buying a put.
Scenario 1: Stock price falls to $60 • Exercise the option: • You have the right to sell KALU stock at $68 per share, even though the market price is only $60 per share. • Profit per share = Strike Price ($68) - Market Price ($60) - Premium ($2) = $6 per share. • Total profit = $6 × 100 = $600.
Scenario 2: Stock price is $66 • Breakeven point: The strike price minus stock price minus the premium. • Profit = Strike Price ($68) - Stock price($66)- Premium ($2) = $0 per share.
• You neither gain nor lose money after accounting for the premium.
Scenario 3: Stock price is $75: • Let the option expire: • The put option is worthless because selling at $68 makes no sense when the market price is $75. • Loss = Premium paid = $200.
*Price of KALU is correct as of 03 February 2025.
Options trading calculator:
While options strategies can be confusing and calculations may not be your forte, Tiger Trade offers tools and educational resources to help investors navigate and explore what opportunities options trading may provide. Tiger Trade offers options calculator on its app to help investors calculate the theoretical price of an option in a given implied volatility and at a specific future time when the stock price is at a certain level. To use this feature log in to Tiger Trade > Quotes > Select Option you want > Option chain > Select the expiry date > find the specific call/put click> scroll down to locate the options calculator.
From here:
Enter the current price of the underlying asset (stock price).
Enter the strike price of the option.
Set the expiration date of the option.
Input the predetermined implied volatility.
Source: Tiger Trade App, price of KALU is correct as of 03 February 2025. Please note trading fees are not considered in the above calculations.
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Capital at risk. Options trading carries a high level of risk and may not be suitable for all investors. You should only trade with money you can afford to lose. See FSG, PDS, TMD and T&Cs via our website before trading. Information provided may contain general advice without taking into account your objectives, financial situations or needs. Past performance is no guarantee of future results. Graphics and charts are for illustrative purposes only. Tiger Brokers (AU) Pty Limited. ABN 12 007 268 386 AFSL 300767
