What is an option?

An Option is a financial derivative that gives the holder the right to buy or sell an asset at a specific price on or before a specific date in the future, but does not carry the obligation to buy or sell. There are two main types of options: Call options and Put options.

The basic elements of options

• Underlying Asset: The asset on which the option is based, which can be stocks, bonds, commodities, foreign exchange, etc., the price of the option will fluctuate with the change of the underlying asset price.
• Strike Price or Exercise Price: The price at which the underlying asset is bought or sold as specified in an option contract.
• Expiration Date: The expiration date of the option contract, the last date by which the option holder must decide whether to exercise the option.
• Option Premium: A fee paid by the buyer to the seller for the right to an option contract. This is called option premium or royalty.
• Call option: Give the holder the right to buy the underlying asset at the strike price on or before the expiration date.
• Put Option: gives the holder the right to sell the underlying asset at the strike price on or before the expiration date.

What is option money?

Option premium, also known as royalty, is a fee paid by the buyer to the seller for the right to an option contract. It is an important concept in the options market and is similar to insurance premiums. The buyer pays the option premium for the right to buy or sell the underlying asset at a specific price at a future time, while the seller, upon receiving the option premium, assumes the obligation to fulfill the option contract. The premium on an option is also the price of the option contract, which is the value of the option bought or sold at the moment.

The calculation of royalty involves a number of factors, mainly including:

• Underlying Asset Price: The current market price of the underlying asset of the option.
• Strike Price: The price at which an option contract agrees to buy or sell the underlying asset. For a call option, intrinsic value is equal to the difference between the current price of the underlying asset and the strike price (if greater than zero), or zero (if less than or equal to zero). For a put option, intrinsic value is equal to the difference between the strike price and the current price of the underlying asset (if greater than zero), or zero (if less than or equal to zero). Therefore, the greater the difference between the exercise price and the underlying asset price, the higher the intrinsic value of the option, thus affecting the overall value of the option.
• Time to Expiration: the remaining active time of an option contract, usually in years or days. The time value of an option is the excess of the option's current price over its intrinsic value. As the expiration time approaches, the value of time will gradually decrease. This is because a shorter expiration time means that the option has less opportunity to realize its intrinsic value, and investors are unwilling to pay a high time value. Therefore, other things being equal, the same option will have a lower price if it has a shorter expiration time.
• Volatility: The volatility of the underlying asset's price, usually expressed as annualized volatility.
• Dividend Yield: If the underlying asset is a stock, the dividend yield also affects the option price.

① The dividend yield increases, and the call option premium decreases, because the high dividend yield means that the stock price will fall after the ex-dividend, which is unfavorable to the call option; Put prices rise because a high dividend yield means that the stock price will fall after the ex-dividend, which is favorable for put options.

(2) As the dividend yield decreases, the call premium increases, because a low dividend yield or no dividend payment means that the stock price will not fall due to the ex-dividend date, thus benefiting the call option; Put prices decline because a low dividend yield or no dividend payout means that the stock price will not fall because of the ex-dividend date, thus working against the put option.

• Market supply and demand: the market supply and demand relationship of options will affect the actual price of the royalty. As demand for options increases, option prices rise; The demand for options is down and the premium on options is down.
• Liquidity: The liquidity of the market also affects the royalty because a less liquid market may have a large bid-ask spread, which is the difference between the highest price a buyer is willing to pay (the bid price) and the lowest price a seller is willing to accept (the ask price). A highly liquid market means that the price difference between buyers and sellers is less, and the price discovery of royalties will be more efficient, and the transaction cost will be lower, which will increase the price of royalties.

Concrete example

Scenario 1: Call Option/Call Option

Xiao Ming buys the call option, a call option has a contract unit of 10,000. So the premium on this call option is 10,000 *3= $30,000. This option gives Ming the right, but no obligation, to buy 10,000 shares of ABC stock at $105 per share after three months. As the seller of the option, Xiao Hong received the option payment of 10,000 *3= $30,000 paid by Xiao Ming. Xiao Hong undertakes to sell 10,000 shares of ABC at $105 if necessary.

Several possible scenarios at expiration:

The stock price is $110: Ming exercises the option to buy the stock at $105 and sell it at the market price of $110, so that his profit per share (110 - $105 - $3) *10000 = $20000.

The stock price is $105: Xiao Ming will not exercise the option because there is no profit (the purchase price is the same as the market price) and his loss is the option money 3*10000= $30000.

The stock price is $100: Xiao Ming will not exercise the option because the market price is below the exercise price and his loss is $30,000.

Scenario 2: Put Option/Put Option

Xiao Hua buys this put option. A put option has a contract unit of 10,000. This option gives him the right, but no obligation, to sell 10,000 shares of stock XYZ at $95 per share after 3 months. As the seller of the option, Xiao Dong received the option payment of 10,000 *2=$20,000 from Xiao Hua. Xiao Dong undertakes the obligation to buy 10,000 shares of stock XYZ for $95 whenever Xiao Hua exercises the sell right.

Several possible scenarios at expiration:

The stock price is $90: Xiao Hua will exercise the option to sell the stock at $95 and buy it at the market price of $90, so that his profit per share (95-90-2) *10000 = $30000.

The stock price is $95: Xiao Hua will not exercise the option because there is no profit (the sell price is the same as the market price), and his loss is the option money 2*10000= $20000.

The stock price is $100: Xiao Hua will not exercise the option because the market price is higher than the exercise price, and his loss is $20,000.

How do I buy options with uSMART?

After logging in the uSMART HK APP, click Discover from the bottom of the page, then click Option at the top of the page, you can enter the option details page to understand the option, click the specific option, click the exercise price number, click "Trade" in the lower right corner, select "buy/sell" function, fill in the trading conditions and unlock the trade. Image operation instructions are as follows: