As a derivative product, the price of option is really depended on the underlying asset that tie to it. For example is it is a ’stock’ option, then the price of the option will be up to the price of the stock. If it is a ‘future’ option, then the price is depended to the ‘future’ price.

To fully understand why option behaves like described below, you need to fully understands how options works. That’s quite a huge task to be covered in this article. This article just want to show you a quick to the point mechanism how option can produces profit for traders.

Call Option and Put Option

Basically, there are 2 kind of option: call option and put option.

1. If you buy a call option, you have a right to buy the underlying asset at predetermined price before certain date.
2. If you buy a put option, you have the right to sell the underlying asset at predetermined price before certain date.

Since it is only a ‘right’ then you don’t have to actually buy or sell the underlying asset. It’s totally up to you.

The Option Triad

The ‘predetermined price’ is also known as strike price and the ‘certain date’ is called ‘Expiry Date’. For example:

• a call option of Microsoft share with strike price of $25 and Expiry date of 15 June means you have the right to buy Microsoft stock at $25 each on or before 15 June. (Imagine if today is 14 June and the price of the stock is $30 each, then holding such call option will be very profitable isn’t it ?)
• a put option of Microsoft share with strike price of $25 and Expiry Date 15 September means you have the right to sell Microsoft stock at $25 each on or before 15 September. (Imagine if today is 14 September and the price of the stock is only $20, then holding such put option will be very profitable, isn’t it ?)

Profit as Option Buyer

First way to profit from option is as option buyer (or also known as option holder):

1. The price of Call Option will go up if the price of the underlying asset go up. And if the price of underlying asset go down, the price of call option also become cheaper.
   For example: if you think stock of Microsoft will go up next month (based of your analysis or tips or gut feeling..), then you can buy call option. If indeed the price of Microsoft stock is going up, then you make profit.
2. The price of Put Option will go up if the price of the underlying asset go down. And if the price of underlying asset go up, the price of put option also become cheaper.
   For example: if you think stock of Microsoft will go down next month , then you can buy put option. If indeed the price of Microsoft stock is going down, then you make profit.

To remember which option to buy if the price go up or down, just remember this phrase: CALL up PUT down (You buy CALL option if you want the price to go up, and buy the PUT option if you expect the price to go down)

Profit as Option Seller/Writer

The seller of the option also know as ‘Option Writer‘. As option writer the profit come from the price of the option when buyer make the transaction this price will be referred as ‘option premium‘. Since the buyer pay the price up front, then it does not matter where the price of the asset will go, the option writer will still pocketing that upfront payment.

But an option writer will require more trading capital and carries more responsibility  or risk than the buyer. Remember, the buyer of call option have the right to buy the asset, then as the seller/writer then he/she will have to sell the asset on that predetermined price. The same mechanism also apply put option.

Hence option trading as seller / writer is considered quite advanced. There will be many strategies that can be used to make sure option writer have real undirectional income from option trading or at least minimize their risk.

Conclusion

• There are 2 kind of options: call option and put option.
• Underlying Asset, Strike Price and Expiry Date are the main parameter of option
• Using option, Trader can make profit as a buyer, as a seller / writer, or even combination of both.

Denis Kristanda