Options: What They Are, How They Work, and Why Investors Use Them

Options are one of the key instruments in the derivatives market, allowing investors not only to profit from price fluctuations but also to hedge risks. Despite their complexity, options are widely used by both institutional and retail investors.

In this article, we will explain what options are, how they work, their different types, where to trade them, their advantages and disadvantages, and how they differ from binary options.

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What is an Option?

An option is a financial contract that gives the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price within a specific period.

Simply put, an option allows an investor to lock in the price of an asset and either exercise the right to buy/sell or let it expire worthless.

It is crucial to understand that options are not binary options. Binary options are highly speculative and have little in common with traditional exchange-traded options, which are used in professional investment strategies.

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How Do Options Work in Investments?

Options can be used for both speculation and hedging.

🔹 Example of speculation: An investor buys a call option on Tesla shares with a strike price of $800 and an expiration date in one month. If Tesla’s stock price rises to $900 within that time, the investor exercises the option and buys the shares at $800, immediately profiting from the price difference. If the stock price falls, the investor simply lets the option expire, losing only the premium paid for it.

🔹 Example of hedging: An investor holds a stock portfolio and wants to protect it against potential losses. They buy a put option, which allows them to sell stocks at a fixed price even if the market declines. This way, they limit potential losses.

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Types of Options

1. Call Option

✔ Gives the right to buy an asset at a predetermined price in the future.
✔ Used when the investor expects the asset price to increase.
✔ If the price does not rise, the investor can simply let the option expire, losing only the premium paid.

2. Put Option

✔ Gives the right to sell an asset at a predetermined price.
✔ Used when the investor expects the asset price to decrease.
✔ Useful as a hedging tool since it allows selling an asset at a fixed price, even if the market falls.

3. American vs. European Options

✔ American options – can be exercised anytime before expiration.
✔ European options – can only be exercised on the expiration date.

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Where Can You Trade Options?

Options are traded on the world's largest exchanges, which provide liquidity and security.

Major Options Exchanges

• Chicago Board Options Exchange (CBOE) – the leading options exchange in the U.S.
• Nasdaq Options Market (NOM) – options on major technology companies.
• NYSE American Options (NYSE AMEX) – a division of the New York Stock Exchange for options trading.
• Euronext – a European exchange offering derivatives trading.
• Hong Kong Exchanges and Clearing (HKEX) – an Asian exchange for regional options markets.
• Moscow Exchange (MOEX) – the largest options trading platform in Russia.

Trading on these regulated exchanges ensures investor protection and compliance with market standards.

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Who Invented Options?

Although modern options were formalized in the 20th century, their origins date back to Ancient Greece.

In today’s financial system, options gained popularity thanks to Fischer Black and Myron Scholes, who developed the Black-Scholes options pricing model in 1973. This model allowed traders to effectively determine the fair value of options and simplified their trading.

That same year, the Chicago Board Options Exchange (CBOE) was established, becoming the first exchange to list standardized options for public trading.

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Advantages and Disadvantages of Options

Advantages:

✔ Flexibility – options can be used for speculation, hedging, and portfolio management.
✔ Limited risk – if an investor does not exercise the option, they only lose the premium paid.
✔ High profit potential – correctly chosen options can generate significant returns.
✔ Various strategies available – investors can create complex options combinations to reduce risks.

Disadvantages:

⚠ Complexity – options require a deep understanding of markets and pricing models.
⚠ Expiration risk – if an option is not exercised in time, it becomes worthless.
⚠ Risk for option sellers – selling options (writing call or put options) can result in unlimited losses if the price moves against the position.
⚠ Time decay effect – the value of options decreases as expiration approaches, making long-term strategies more challenging.

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Difference Between Traditional Options and Binary Options

Many beginner investors confuse options with binary options, but they are completely different financial products.

Feature	Traditional Options	Binary Options
Where they are traded	Official exchanges (CBOE, NYSE, MOEX)	Mostly unregulated platforms
Contract structure	Gives the right to buy or sell an asset	A bet on price movement within a set time
Risk control	Can exit the position at any time	Once entered, no changes can be made
Legality	Fully regulated	Banned in some countries due to gambling risks

Binary options are often used in scams and have nothing in common with real options trading.

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Conclusion

Options are a powerful investment tool that allows investors to profit from price movements and protect their assets from losses. They are actively traded on the world’s largest exchanges and play a crucial role in modern financial markets.

However, options require a solid understanding of market mechanics, proper strategy selection, and strict risk management. They can be a high-return instrument, but if misused, they can also lead to significant losses.

 

For successful options trading, investors must study the basic strategies, understand time decay effects, assess risk, and choose reputable exchanges and brokers.