Options Trading Basics
A comprehensive introduction to the world of options for beginners and advanced traders.
What Are Options?
Options are financial derivatives that give the buyer the right (but not the obligation) to buy or sell an underlying asset at a predetermined price (strike) before or on a specific date (expiration).
Call Option
A call option gives the buyer the right to buy the underlying asset at the strike price. Buyers profit from rising prices.
Put Option
A put option gives the buyer the right to sell the underlying asset at the strike price. Buyers profit from falling prices.
Strike Price (Exercise Price)
The predetermined price at which the underlying asset can be bought or sold when the option is exercised.
Expiration Date
The date by which the option can be exercised. After this date, the option expires worthless if not exercised.
Option Premium
The price the buyer pays for the option. The premium consists of intrinsic value and time value.
How Do Options Work?
Buyer and Seller: Rights and Obligations
Every options trade involves two parties: the buyer (holder) and the seller (writer). The buyer pays the premium and receives a right in return. The seller collects the premium and takes on an obligation. This fundamental principle is the most important building block for understanding options.
The buyer of a call option has the right to buy the underlying asset at the strike price. The seller of that call option is obligated to deliver the underlying asset at the strike price if the buyer exercises their right. Conversely, the buyer of a put option has the right to sell, while the put seller is obligated to buy.
Think of it like insurance: the buyer pays a premium for protection (the right), and the seller assumes the risk in exchange for payment. The premium is the maximum loss for the buyer, but also the maximum profit for the seller. The potential loss for the seller, however, can be significantly higher.
Reading and Understanding Option Chains
An option chain is a table that displays all available options for a specific underlying asset. It is the most important tool for every options trader. Typically, calls are shown on the left side and puts on the right side, with strike prices listed in the middle.
Each row shows a strike price with its associated data: bid price, ask price, last traded price, volume (number of contracts traded that day), and open interest (total number of outstanding contracts). For BMW stock trading at 100 EUR, you might see calls with strikes of 90, 95, 100, 105, and 110 EUR, each with different premiums.
Volume and open interest are particularly important: high volume means many contracts are being traded and you can easily enter and exit positions. High open interest shows that many open positions exist. Both together indicate a liquid option where the difference between bid and ask (the spread) is small.
American vs. European Style Options
The difference between American and European options refers not to the trading location, but to the exercise timing. American options can be exercised at any time up to the expiration date. European options can only be exercised on the expiration date itself.
In practice, most stock options on US exchanges are American style, while index options (e.g., on the DAX or S&P 500) are often European style. For beginners, the difference is often negligible since most traders sell options before expiration rather than exercising them. However, it is important to know that with an American option, you can be assigned at any time if you hold the seller side.
A practical example: if you hold an American call option on SAP with a 150 EUR strike and the price rises to 170 EUR, you can exercise the option immediately and buy the shares for 150 EUR. With a European option, you would have to wait until the expiration date — although you can of course sell the option on the market at any time.
In the Money, At the Money, Out of the Money
The moneyness status of an option describes the relationship between the current price of the underlying asset and the strike price. This concept is fundamental to option valuation and determines whether an option has intrinsic value.
In the Money (ITM)
The option has intrinsic value. For calls, the price is above the strike; for puts, it is below the strike.
Call Example:
BMW at 108 EUR, Strike 100 EUR → 8 EUR in the money
Put Example:
BMW at 92 EUR, Strike 100 EUR → 8 EUR in the money
At the Money (ATM)
The price of the underlying roughly equals the strike price. The option has no intrinsic value, but the highest time value.
Call & Put Example:
BMW at 100 EUR, Strike 100 EUR → At the money
Intrinsic value: 0 EUR. The entire price consists of time value.
Out of the Money (OTM)
The option has no intrinsic value. For calls, the price is below the strike; for puts, it is above the strike. The option consists only of time value.
Call Example:
BMW at 95 EUR, Strike 100 EUR → 5 EUR out of the money
Put Example:
BMW at 105 EUR, Strike 100 EUR → 5 EUR out of the money
Why does this matter? ITM options are more expensive but have a higher probability of ending profitably. OTM options are cheaper and offer higher leverage, but expire worthless more often. ATM options offer a middle ground and react most strongly to price movements of the underlying (they have the highest gamma). As a rule of thumb: about 70% of all options held to expiration end up worthless.
Intrinsic Value and Time Value
The price of an option (the premium) is composed of two components: intrinsic value and extrinsic value (also called time value). Understanding this breakdown is crucial because it explains why options become more or less expensive.
Intrinsic value is the amount by which an option is in the money. For a call option, it is the difference between the current price and the strike price (if positive). For a put option, it is the difference between the strike price and the current price (if positive). At-the-money or out-of-the-money options have zero intrinsic value.
Time value represents the possibility that the option may gain value before expiration. It is influenced by the remaining time to expiration, the volatility of the underlying, and interest rates. The longer the remaining time and the higher the volatility, the greater the time value. On expiration day, time value is zero — the option is then worth only its intrinsic value.
Numerical Example: Premium Breakdown
Underlying: SAP stock, current price 180 EUR
Option: Call, Strike 170 EUR, 60 days to expiration
Current Premium: 15 €
Breakdown:
Intrinsic Value
10 €
(180 € - 170 €)
Time Value
5 €
(15 € - 10 €)
With 60 days remaining, nearly one-third of this option's price consists of time value. If only 10 days remained, the time value would be significantly lower — perhaps only 1-2 EUR. This decay of time value accelerates in the final weeks before expiration and is known as theta decay.
Understanding Option Contracts
Contract Size: 100 Shares per Contract
A standard options contract on US exchanges covers 100 shares of the underlying asset. So when you buy an option for 3 EUR per share, you actually pay 300 EUR for the entire contract (3 EUR x 100 shares). This multiplier applies to all standard equity options and is key to understanding the actual costs and profits.
On European exchanges like Eurex, contract sizes may vary. DAX options, for example, have a multiplier of 5 EUR, while equity options on individual stocks like BMW or SAP also typically cover 100 shares. Always check the contract specifications of your exchange.
The Leverage Effect in Options
Options offer natural leverage: you control a large position with a relatively small capital outlay. This leverage is one of the main reasons traders use options. It works in both directions — it multiplies both gains and losses (relative to the capital invested).
Leverage is calculated as: (stock price x 100) / (option premium x 100). If BMW stock is at 100 EUR and a call option costs 3 EUR, the leverage is 100/3 = 33.3. This means: a 1% change in the stock price can cause up to a 33% change in the option's value. In practice, actual leverage is somewhat lower and depends on the option's delta.
Cost Comparison: Buying Shares vs. Buying an Option
The following comparison shows why options are attractive to some investors — and where the risks lie.
Buy 100 BMW Shares
Capital required: 100 × 100 € = 10.000 €
Price rises to 110 EUR: Profit 1,000 EUR (+10%)
Price falls to 90 EUR: Loss 1,000 EUR (-10%)
Max loss: 10,000 EUR (total loss)
Buy 1 Call Option (Strike 100 EUR)
Capital required: 5 € × 100 = 500 €
Price rises to 110 EUR: Profit 500 EUR (+100%)
Price falls to 90 EUR: Loss 500 EUR (-100%)
Max loss: 500 EUR (only the premium)
With a 10 EUR increase, the stockholder earns 1,000 EUR on 10,000 EUR invested (10% return). The option buyer earns 500 EUR on 500 EUR invested (100% return). However, the option buyer loses their entire 500 EUR if the price is not above the strike at expiration. The stockholder, on the other hand, still owns their shares and can wait for a recovery.
Practical Examples
Buying a Call Option
Underlying: BMW stock, current price 100 EUR
Strike: 105 €
Expiration: 3 months
Premium: 3 € per share
Scenarios:
- Price rises to 115 EUR: Profit of 7 EUR per share (115 - 105 - 3)
- Price stays at 100 EUR: Option expires, loss of 3 EUR (premium)
- Price falls to 90 EUR: Option expires, loss of 3 EUR (premium)
Buying a Put Option
Underlying: BMW stock, current price 100 EUR
Strike: 95 €
Expiration: 3 months
Premium: 2 € per share
Scenarios:
- Price falls to 80 EUR: Profit of 13 EUR per share (95 - 80 - 2)
- Price stays at 100 EUR: Option expires, loss of 2 EUR (premium)
- Price rises to 110 EUR: Option expires, loss of 2 EUR (premium)
Note the difference: with a call, you profit from rising prices and hope the price rises above the strike. With a put, you profit from falling prices and hope the price falls below the strike. In both cases, your maximum loss is limited to the premium paid.
Key Takeaways
- ✓Options give the right, but not the obligation, to buy/sell
- ✓Maximum risk for buyers is limited to the premium
- ✓Options expire worthless if they are not in the money
- ✓One option contract typically covers 100 shares
Common Beginner Mistakes
Options trading offers many opportunities, but beginners frequently fall into the same traps. Knowing these typical mistakes helps you avoid them from the start.
1. Buying Too Far Out of the Money
Cheap OTM options seem tempting because they cost little. But the probability that they finish in the money is low. A BMW call option with a 150 EUR strike at a price of 100 EUR might cost only 0.20 EUR, but the stock would need to rise 50% for it to profit. Most of these options expire worthless.
2. Underestimating Time Decay
Every day, an option loses some time value (theta). This decay accelerates dramatically in the last 30 days before expiration. Beginners often hold options too long and wonder why the value drops even though the underlying barely moved. Plan your exit before time decay eats into your position.
3. Taking Positions That Are Too Large
Because options seem cheap, beginners often buy too many contracts. 10 contracts of an option at 2 EUR means a 2,000 EUR investment (10 x 100 x 2 EUR) — money that can be completely lost. A proven rule: never risk more than 2-5% of your trading capital on a single trade.
4. Trading Without an Exit Plan
Many beginners buy options without defining when to sell — neither at a profit nor at a loss. Before every trade, define: at what profit do I take gains? At what loss do I exit? Without clear rules, emotions like greed and fear lead to poor decisions.
5. Ignoring Implied Volatility
Implied volatility (IV) significantly affects the option price. Before earnings reports or major events, IV is often high, making options expensive. After the event, IV drops (volatility crush), and the option rapidly loses value — even if the price moves in the right direction. Always check IV before buying.