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1. Introduction to Options

Options are financial derivatives that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price before or on a predetermined date. Unlike stocks, where ownership is outright, options are contracts with specific conditions.

Underlying asset: Can be stocks, indices, commodities, currencies, or ETFs.

Strike price: The price at which the option can be exercised.

Expiration date: The date on which the option contract expires.

Premium: The price paid by the buyer to acquire the option.

Options are categorized into two main types:

Call Options: Give the holder the right to buy the underlying asset at the strike price.

Put Options: Give the holder the right to sell the underlying asset at the strike price.

2. The Mechanics of Option Trading

Option trading involves two parties: the buyer (holder) and the seller (writer).

Option Buyer (Holder):

Pays a premium for the right.

Can choose whether to exercise the option.

Risk is limited to the premium paid.

Option Seller (Writer):

Receives the premium.

Obliged to fulfill the contract if the buyer exercises.

Risk can be unlimited (for naked calls) or limited (for covered positions).

Key Features of Options

Leverage: Options allow controlling a large number of shares with a relatively small investment.

Limited Risk for Buyers: Buyers can only lose the premium paid.

Flexibility: Options can be used for speculation, hedging, or income strategies.

Time Decay: Option value declines over time, especially for out-of-the-money options.

Volatility Sensitivity: Options pricing is heavily affected by changes in market volatility.