In the derivatives market, apart from futures, there is another very important financial investment tool. It has a stronger speculative nature, higher returns, and a very interesting trading method that is different from stocks, futures, and securities. It is quite fascinating, and that is the option we are going to discuss.

I. The Concept of Options

Since it is called "option," an option is a kind of right.

The buyer of an option pays money to acquire the right to buy or sell a certain quantity of a specific commodity or financial instrument at a predetermined price within an agreed-upon time frame.

On the other hand, the seller of an option, after receiving funds from selling the option, is obligated to sell or buy a certain quantity of a specific commodity or financial instrument from the buyer at the predetermined price when the buyer exercises the option.

Let's use an example to simply illustrate what an option is.

We can understand an option as a promise note sold by the seller to the buyer.

For instance, Zhang San is a pork vendor,

who sold a promise note to Li Si at a price of 10 units of currency,

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promising that for the next month, whenever Li Si wishes, he can come to the store and buy 10 jin (a unit of weight) of pork at a price of 50 units of currency.This commitment letter can be understood as a pork option contract, where 10 yuan represents the option premium, and 50 yuan is the exercise price.

Zhang San, as the seller, earns 10 yuan by selling this contract.

If the price of 10 jin (a unit of weight) of pork is cheaper than 50 yuan within the next month, then Li Si will not exercise the option, losing the 10 yuan spent on buying the commitment letter.

However, if the price of pork rises and 10 jin of pork is more expensive than 50 yuan, then Li Si will present this commitment letter to Zhang San and buy 10 jin of pork at the price of 50 yuan.

Assuming the price of pork soars, and 10 jin of pork costs 200 yuan, then Li Si can buy pork worth 200 yuan for 50 yuan, plus the previous cost of 10 yuan, which is equivalent to Li Si making a profit of 140 yuan. Similarly, Zhang San would incur a loss of 140 yuan.

Thus, the maximum loss for the buyer of an option is the premium of 10 yuan, and the maximum profit depends on how much the price of pork increases.

On the other hand, the seller can earn a maximum of 10 yuan in premium, and the maximum loss also depends on how much the price of pork rises.

This is the interesting aspect of options, where gains and losses are not linear.

II. Constituent elements of options

1) Underlying assetThat is, what assets we trade through options, which is the most basic element of an option. The underlying asset can be spot assets, futures assets, physical assets, financial assets, financial indicators (such as stock index options), etc.

(2) Option price (premium)

Also known as the premium or option fee, it refers to the cost that the buyer of the option must pay to obtain the right to exercise the option. (Note to distinguish it from the exercise price).

(3) Exercise direction

That is, the operational direction of the option buyer when using the right. Simply put, when exercising the right, are you buying or selling the asset.

(4) Exercise price (strike price)

Also known as the strike price, when the option buyer exercises the right, they can buy or sell (depending on the exercise direction) the specified quantity of the underlying asset at this price (strike price) as stipulated in the option contract.

(5) Expiration period

After purchasing an option, it is not perpetually valid; it can only be exercised or not exercised within the period specified in the option contract. If the period is exceeded, the option becomes void.

III. Characteristics of options(1) Options, like futures, can be traded in both directions, allowing for both the purchase and sale of options.

(2) The rights and obligations of the buyer and seller are different. The buyer pays a premium to the seller, obtaining the right to exercise the option. The buyer can choose to exercise or not exercise the option without assuming the corresponding obligations. The seller, on the other hand, must fulfill the obligation to sell or buy the underlying asset when the buyer exercises the option.

(3) The characteristics of gains and risks for both parties are different. After purchasing an option, the buyer's maximum loss is the premium paid, while the potential profit is substantial. Conversely, the seller's maximum gain is the premium received from selling the option, but the potential loss is significant.

(4) The requirements for margin payments by both parties are different. The buyer's maximum risk is the premium already paid, so there is no need to pay a margin. However, since the seller's potential loss is substantial, they are required to pay a margin as a guarantee to fulfill the agreement.

I will continue to introduce options to you and explain the interesting aspects of options. I hope you can give a follow and support.