Everything you need to know about options

What are the characteristics of an option?

When you’re learning about options, it’s important to know that each option has six key characteristics that define how it works. These are the building blocks of every option, whether you’re buying or selling:

The premium is the price you pay to buy the option. Think of it as the cost of admission to get the right (but not the obligation) to buy or sell an underlying asset, like a stock. For example, if you want to buy an option, you’ll pay this upfront fee to the seller.

The strike price is the set price at which you can choose to buy (call option) or sell (put option) the underlying asset. This is the price you lock in when you buy the option. For example, if you buy a call option with a strike price of $50, you have the right to buy the asset at $50, even if its market price goes higher. It’s like securing a deal now for something you might want in the future.

Every option has an expiration date, which is the deadline for deciding whether to exercise your option or let it expire. After this date, the option is no longer valid, and you lose the right to buy or sell the asset. It's important to pay attention to this date because it’s the window of time in which you can potentially make a move. Think of it like a coupon with an expiration date—you have to use it before it expires!

The contract size refers to the amount of the underlying asset that the option gives you control over. Typically, one options contract represents 100 shares of the underlying asset. So, if you buy one option, you’re actually buying the right to buy or sell 100 shares. This is helpful to remember because the price of an option is often quoted per share, but you’ll be dealing with 100 shares in most cases.

The exercise style tells you when you’re allowed to exercise the option. It’s good to know and understand which type you have, because it affects how flexible you can be with your timing.

There are two main styles:


• American-style options can be exercised any time before the expiration date.
• European-style options can only be exercised on the expiration date itself.

The settlement style refers to how the option is settled when you exercise it.


• Cash settlement means you’ll receive the difference in cash between the strike price and the current market price of the asset.
• Physical settlement means the actual asset (like shares of stock) will be delivered to you at the strike price if you exercise the option.

These six characteristics collectively are the foundation of any options contract. Understanding each one will help you feel more prepared as you learn more about options trading. Just take your time, always keep learning, and before you know it, you’ll feel ready to begin investing in options.

What are the types of options?

There are two types of options: call options (buying rights) and put options (selling rights).

With a purchased call option, you are allowed to buy a particular stock for a certain amount of money within a defined period of time. You pay the call premium for this right. The value of this call premium moves in line with the development of the underlying asset.

If the underlying asset, such as a stock, increases in value, the price of the call increases. The reverse is also true. If the underlying asset falls in price, the price of the call usually decreases.

On the other hand, a bought put option gives the right to sell a certain underlying asset. You also pay a premium for a put option.

The value of this put premium moves in the opposite direction of the stock itself. If the stock falls, the price of the put usually increases. For this reason, a put option is also known as an 'insurance premium for stocks.'

The reverse is also true. If the underlying asset rises in price, the price of the put usually decreases.

Why trade options?

Options offer many advantages for traders and investors, including:

• Income through premiums. Regularly selling options can create a possible stream of income from the premiums collected.
• Potential for higher returns. You may earn income when you buy a stock at a discount relative to its later valuation at expiration. Returns can also be higher because options are inherently leveraged investments, so a change in the price, or volatility in the underlying asset, could cause a noteworthy change in the price of the option.
• Safety net. Options can also act like an insurance policy for your investments. If you own a stock that you think might decline soon, you can use options to help limit your losses.
• More with less. One of the advantages of options is that you can control a large amount of stock for a fraction of the cost. This means you can potentially earn more while risking less of your money.

What is an option chain?

An option chain is a detailed table that shows all the available options for a particular stock or asset. If you’re new to options trading, think of the option chain as a menu of choices that helps you explore different strategies for buying or selling options.

It lists both call options (which give you the right to buy a stock) and put options (which give you the right to sell a stock) at specific prices, known as strike prices. Along with that, you'll also see expiration dates, which indicate how long you have to decide whether to use that option.

The option chain organizes this information so you can compare the option prices, volatilities and Greeks across different strike prices and expirations. While it might seem complex at first, it’s designed to give you a clearer picture of all the available choices, helping you make more informed decisions based on your financial goals and risk tolerance.

Over time, you’ll become more comfortable navigating the chain, and it’ll start to feel like a powerful tool that helps you better understand and manage your investments. Don't worry if it seems overwhelming at first—it's perfectly normal, and each step forward brings more confidence.

What is the difference between stocks and options trading?

There are several ways that stocks and options differ.

Stocks are quite simple to understand and are, therefore, well-suited for individuals who are just beginning to invest. Options can be quite complicated, which is why they may be better suited for more experienced investors and traders.

Another difference is that, with stocks, the initial capital required is usually equal to the stock price. However, with options, the initial capital required is much lower than the stock price.
In simple terms, this means that buying an option on the equivalent amount of stocks costs less than buying the stock outright.

Stocks also give investors the opportunity to own an equity stake in a business, whereas options do not offer ownership in a business, as they are a derivative.

How does options trading work?

Options trading might seem a bit intimidating at first, but it’s actually a flexible and exciting way to invest once you get the hang of it. So how exactly does it work?

First, let’s make sure it’s clear exactly what an option is and then we’ll get into the specifics of how it works.

An option is a financial instrument based on the value of an underlying security, such as a stock. When buying an options contract, you are paying for the option to buy or sell the underlying security within a specific timeframe.

In simple terms, you are paying for the option to buy or sell an asset within a given period, at a specified price, but you are not required to do so.

There are a few key components of an option contract that we should also mention:


• Strike price. The price at which the underlying instrument will be bought or sold if the option is exercised.
• Expiration date.  The last date on which the holder of the option may exercise it.
• Contract Size. The quantity of the underlying asset that an options contract represents.

When you trade options, you're essentially buying or selling contracts that give you the right, but not the obligation, to buy or sell an asset at a specific price (known as the strike price) within a certain period of time.

There are two main types of options: calls and puts. A call option gives you the right to buy the asset at the strike price, while a put option gives you the right to sell it.

What makes options special is that you don’t have to own the asset to buy an option on it. You’re simply paying for the choice, which is why options can be a lower-cost way to potentially profit from a stock’s movement.

However, options do expire, so you must decide before that date whether to exercise your option or let it expire. If the asset moves in the direction you expected, you can either buy or sell the asset at that strike price for a profit or sell the option itself for a gain.

On the flip side, if the asset doesn't move as you hoped, you might lose the money you paid for the option, but your losses are limited to just that amount.

Options trading offers a lot of flexibility and opportunities, and while there’s a learning curve, it’s a tool that many investors use to enhance their investing and trading strategies.

It’s totally okay to take it slow and learn as you go—there’s no rush– and understanding the basics of how they work really is the first step to feeling more confident.

What does it mean to go long and short with options?

When trading options, you can either go long (buy an option) or go short (sell an option). Let's break down what each of these means:

Long Call Option: When you buy a call option, you're hoping the price of the underlying asset will go up. Buying a call gives you the right to buy that asset at a specific price (called the "strike price") before a certain date. You’ll pay a fee, called a premium, for this right. And if the asset’s price goes higher than your strike price, you can buy it at the lower price, then sell it at the higher market price to make a profit. If the price doesn’t go up, you just lose the premium you paid.

Long Put Option: When you buy a put option, this means you're expecting the price of the asset to go down. Buying a put gives you the right to sell the asset at a set price (the strike price). So if the asset’s price drops below your strike price, you can sell it at the higher price and then buy it back at the lower market price, making a profit. If the price stays high, you lose only the premium you paid.

Short Call Option: When you sell a call option, you’re giving someone else the right to buy an asset from you at a certain price. You collect a premium (the fee paid by the buyer) for this. But if the asset’s price goes up, the buyer will likely exercise the option, meaning you’ll have to sell it to them at the lower strike price, potentially at a loss.

Short Put Option: When you sell a put option, you’re giving someone the right to sell an asset to you at a certain price. You collect the premium for this. If the asset’s price drops, the buyer might exercise the option, and you’ll have to buy the asset at the higher strike price, which could result in a loss.

A simple summary:

GOING LONG = BUYING

GOING SHORT = SELLING

• Going long means you're buying a call or put option, hoping that you will profit if the market moves in your favour (up for a call, down for a put).
• Going short means you're selling a call or put option and collecting the premium, but you’re also taking on the risk of losing money if the market moves against you.

In both cases, you’re speculating on how the market will move, but going long lets you control your maximum risk (the premium you paid), while going short opens up the potential for more significant losses.

How is the P/L determined at Expiry?

For both long and short positions, the payoff defines the profit or loss when the option reaches its expiration:

• Long Call Payoff.  At expiry, the payoff for the buyer of a call option depends on whether the underlying asset’s price is above the strike price.
  • If the asset price is above the strike price, the buyer can exercise the option, buying the asset at the strike price, resulting in a payoff equal to the asset price minus the strike price, less the premium paid.
  • If the asset price is below the strike price, the option expires worthless, and the buyer loses the premium paid.
• Short Call Payoff.  At expiry, the writer of the call faces a potential obligation to deliver the asset if the buyer exercises the option.
  • If the asset price is above the strike price, the writer must deliver the asset at the strike price, incurring a loss that increases as the asset price rises. However, the loss is reduced by the premium initially received.
  • If the asset price is below the strike price, the option expires worthless, and the writer keeps the entire premium as profit.
• Long Put Payoff.  For the buyer of a put, the payoff at expiry depends on whether the underlying asset’s price is below the strike price.
  • If the asset price is below the strike price, the buyer can exercise the option, selling the asset at the strike price, and the payoff is the strike price minus the asset price, less the premium paid.
  • If the asset price is above the strike price, the option expires worthless, and the buyer loses only the premium paid.
• Short Put Payoff. The writer of a put has the obligation to buy the asset if the buyer exercises the option.
  • If the asset price is below the strike price, the writer must buy the asset at the higher strike price, incurring a loss that increases as the asset price falls, though this loss is partially offset by the premium received.
  • Short Put Payoff.  If the asset price is above the strike price, the option expires worthless, and the writer retains the premium as profit.

In simple terms:

Long positions, whether calls or puts, come with limited downside since the most you can lose is the premium you paid. With calls, there’s no ceiling on how much you can gain, while for puts, your max profit is capped at the strike price multiplied by the contract size and number of contracts - basically, what you’d make if the stock went all the way to zero.

Short positions, on the other hand, have limited profit potential since the most you can earn is the premium you received upfront. But the risks are higher: short calls have unlimited risk, while short puts have a maximum loss that’s capped at the strike price times the contract size and number of contracts, which would happen if the stock fell to zero.

What are option strategies?

When trading options, you first have to understand the current market conditions, and then we recommend developing a strategy that suits your risk tolerance and financial goals.

Here are a few strategies commonly used by option sellers:


• Covered calls. If you own shares of a stock, you might consider selling call options on that stock to generate additional income. This strategy is known as writing covered calls.
• Cash-secured puts. Another strategy is selling put options while having the necessary cash to purchase the underlying stock if it gets assigned. This strategy, known as cash-secured puts, allows you to potentially buy the stock at a lower price while earning a premium.
• Vertical spreads. A vertical spread is one of the most common options trading strategies. It involves the simultaneous purchase and sale (a call or put) of the same option with the same expiration date, but different strike prices.

How to know what options to buy?

Deciding which options to buy comes down to understanding your personal investing and trading goals and how you expect a stock to move. Start by considering whether you're bullish (expecting the stock price to go up) or bearish (expecting it to go down).

If you believe a stock’s price will rise, buying a call option gives you the right to buy that stock at a set price, which can be profitable if the stock goes up.

On the other hand, if you think the stock will drop, a put option allows you to sell at a higher price than the market might offer in the future. You’ll also need to choose a strike price - the price at which you can buy or sell the stock - and an expiration date, which is how long the option is good for.

In general, options with strike prices closer to the current stock price and with more time before they expire tend to be more expensive, but they also offer more potential for profit. It’s all about balancing your confidence in the stock’s movement with your risk tolerance, and starting with small, simple trades until you feel more comfortable is always a good idea.

When considering which options to buy, we recommend that you:


1. Define your investing and trading goals.
2. Be honest with yourself about your tolerance for risk.
3. Consider current global events and if/how they may affect market volatility.
4. Create a strategy that considers your goals and risk tolerance.
5. Choose options with expiration dates and strike prices that align with your strategy.

What are the Option Greeks?

In finance, the Greeks are measures of the sensitivity of an option’s price to changes in various factors, such as the price of the underlying asset, implied volatility, or the time to expiration. The Greeks are named after Greek letters that represent them, such as Delta, Theta, Gamma, Veg and Rho.

• Delta. An estimate of how much an option’s price will move given a change in the price of the underlying asset. Delta ranges from 0 to 1 for call options and from -1 to 0 for put options. For example, if the call has a delta of 0.5, and a price of 2 and the stock rises, by 1 then the option price would be 2.5. The option delta depends on the stock price, strike price, volatility, interest rates, dividends, and time to expiration.
• Theta. An approximation of the decrease in the price of an option over time, with all other factors held constant. For example, if a call has a price of USD 3 and a theta of 0.10, one day later, with all else unchanged, the call would have a price of USD 2.90 (USD 3 - (0.10 x 1)).
• Gamma. An approximation of the change in Delta relative to a change in the price of the underlying stock when all other factors are held constant. Gamma is important for understanding how stable an option’s Delta is, especially for traders managing large portfolios of options.
• Vega. A measure used to describe the change in value of an option when the volatility of the underlying asset changes. Vega is crucial for option strategies that depend on volatility shifts. A higher Vega will mean that the option’s price is much more sensitive to changes in volatility, while a lower Vega will indicate less sensitivity.
• Rho. A measure used to describe the change in value of an option when there is a change in interest rates. Rho is more significant for options with longer expiration dates, since interest rates impact the time value of money more over extended periods.

What is the difference between American and European options?

The two main option styles are American and European. It’s important to understand that these two style names do not refer to where the options are listed– they actually refer to the contract specifications. Here’s what we mean by that.

With an American-style option, the buyer can exercise the option at any time during the term (until the option expires) and the writer is obligated to comply. This right of exercise throughout the term poses additional risk for the seller/writer of the option because the option could continue to increase in value at any time before the expiration date. So if you sell early then you wouldn’t profit on any future gains, which would be a missed opportunity.

With a European-style option, you cannot exercise the option at any time– it can only be exercised by the buyer on the contract expiration date. Index options are typically European-style options. If you hold an index option until maturity, it will be settled by cash. This is done at the so-called settlement price. This price is set by the stock exchange according to certain standard rules. At Euronext, the settlement price of the AEX is determined based on the average position of the AEX between 15:30 and 16:00 on the expiration date.

Example: You have a call AEX December with a strike price of 750.00 in your portfolio. The contract size of the AEX option is 100. The expiration rate of the AEX is 760.00 on the third Friday of the month. The call option is therefore 10 points in-the-money. There is a cash settlement of 10 * 100 = EUR 1,000.

Are there risks with trading options?

As with any financial instrument, there are always risks to consider when you trade or invest.

Here are a few risks that come along with trading options, as well as a few suggestions of strategies you can use to mitigate your risks.

• Potential for Large Losses. Selling options can potentially lead to substantial losses, especially if the market moves sharply against your position. It is essential to be aware of the potential losses and to manage your risk appropriately.
• Margin Requirements. When you sell options, you are required to maintain a margin account. This means that you need to have a certain amount of capital in your account as a security. Being aware of the margin requirements is vital to manage your risk effectively.
• Early Assignment Risk.  There is always a risk of early assignment when selling options. Early assignment happens when the buyer of the option chooses to exercise their right to buy or sell the underlying asset before expiration. This risk can be managed by keeping an eye on the intrinsic value of the option and being prepared to take action if necessary.

To mitigate these risks, there are strategies you can use:


• Setting Stop Losses. One strategy is to set stop losses to limit potential losses. A stop loss is an order placed to buy or sell once the stock reaches a certain price.
• Spreads. Another strategy is to use spreads to limit potential losses. In a spread, you sell one option while simultaneously buying another, helping to cap both the potential profits and losses.
• Hedging. Though we are trying to keep it simple here, know that there are advanced strategies like hedging that can further help in managing your risks, which you might want to explore further as you become more comfortable with options trading.

Are options traded on margin?

Options can be traded on margin, and margin requirements vary. These requirements serve as collateral to secure a position, unlike stock and futures margins, which are used as leverage.

We recommend thoroughly understanding the margin requirements for any trade you are considering, to ensure you can meet them if the market becomes volatile.

Margin must be maintained to cover potential losses when writing options. Saxo Bank determines the margin amount required, which can vary per underlying asset. If you cannot meet margin requirements, the deficit procedure will be triggered, and the option may be closed by Saxo Bank.

By using option strategies, you can enter constructions that reduce the margin required.

Options trading can offer some incredible opportunities for investors– if you understand the basics, so keep learning as much as you can about them and soon, you’ll feel ready.

Informed investors can use options to diversify their investment portfolio, manage risk, and potentially increase returns.