Options Playbook: Understand Buying and Selling Strategies to Avoid Infinite Loss Traps

Do you think you can only make money by buying low and selling high? Actually, that’s not the case. Options, this financial derivative instrument, allow you to profit in bear markets, bull markets, and even sideways markets. But the problem is, many people are intimidated by the complexity of options. Today, I’ll quickly guide you to get started.

What exactly are options?

Simply put, options (also called choice rights) are contracts that give you the “right” to buy or sell an asset at a fixed price in the future, not the obligation. You pay a small amount of money to obtain the right to buy or sell an asset at a certain price later on. The asset can be stocks, currencies, indices, commodities, or even futures contracts.

Why use options? Three core advantages:

1. Control large assets with little money — Pay only a small margin to control assets far exceeding your investment
2. Trade in any market condition — Profit from rising markets, falling markets, or sideways consolidation with strategies
3. Hedging tool — Hold stocks and worry about a decline? Buy a put option for insurance

However, this also means you need broker approval. Before starting options trading, you must fill out an options agreement, allowing the broker to assess your financial strength, trading experience, and options knowledge.

Five essential options terms

• Call — The right to buy an asset at an agreed price
• Put — The right to sell an asset at an agreed price
• Premium — The fee you pay to the seller for the option
• Strike Price — The agreed price to buy or sell the asset
• Expiration Date — The date when the options contract expires; after this, your rights become invalid

6 key points to check in an options contract

When beginners start reading options quotes, don’t be scared. Each contract contains the following basic elements:

1. Underlying Asset — The item you want to buy or sell (e.g., a stock)
2. Trade Type — Call or put
3. Strike Price — The fixed buy or sell price
4. Expiration Date — The last date you can exercise this right; choosing the wrong date can directly affect your strategy
5. Options Price — The amount you pay to the seller
6. Contract Size — For US stocks, each options contract represents 100 shares, so the actual premium paid = options price × 100

The four main options strategies, with vastly different risks and rewards

Options are divided into buying and selling, calls and puts, forming four basic strategies.

1. Buying a call option — Expecting a surge

You buy a call option, which is like getting a “discount coupon.” Suppose you buy a Tesla (TSLA.US) call option when the stock price is $175, with an options price of $6.93, and a strike price of $180. You pay $693 (6.93 × 100) for this coupon.

If the stock price stays below $180, you abandon the coupon, losing only the $693, with no further loss. But if the stock rises to $200, you can buy at $180 and sell at $200, earning the difference. The higher the stock price, the more you earn. That’s the play of buying a call option.

2. Buying a put option — Expecting a decline

This time, you buy the “right to sell cheaply.” The lower the stock price drops, the more you profit. Similarly, if the stock doesn’t fall as you expected, your maximum loss is the premium paid for the option. The risk is capped, which is the advantage of a buying strategy.

3. Selling a call option — Dangerous game

Options are zero-sum games; the buyer wins, the seller loses. If you sell a call option without owning the underlying stock, you are taking on unlimited risk. For example, you collect $100 in premium, but if the stock surges skyrocketing / surge, you must buy high and sell low to the buyer, potentially losing far more than the $100 received. This is a “win some, lose some” scenario.

4. Selling a put option — Collect premium but bear risks

You hope the stock price rises or stays stable, so you keep the premium received from selling the option. But what if the stock crashes? For example, with a put option with a strike of $160 and a premium of $361, if the stock drops to zero, you are forced to buy 100 shares at $160 each, which is worthless, resulting in a loss of up to $15,639 (160 × 100 - 361). The risk of selling options far exceeds buying; don’t forget that.

How to avoid losing everything on options?

Options risk management has four tips:

Avoid net short positions

Don’t sell too many options. Selling options creates short positions with unlimited losses, much riskier than buying options. If you use multiple options strategies, make sure to check whether you are net long (more bought than sold), neutral (equal), or net short (more sold than bought). If you find yourself unintentionally becoming net short, quickly buy some options to balance, so you know your maximum potential loss.

Control position size

Don’t put all your chips into one strategy. If your options strategy requires paying premiums upfront, be prepared that this money could be lost entirely. Options can amplify gains and losses, so don’t decide your trading size based on margin alone; consider the actual total value of the contract.

Diversify investments

Don’t allocate all your funds into options on a single stock, index, or commodity. Build a reasonable portfolio to reduce single-point risk.

Set stop-loss

For strategies involving net short positions, stop-loss is crucial because losses can be unlimited. In contrast, for net long and neutral options strategies, stop-loss requirements are less strict because maximum losses are already known.

Options vs futures vs CFDs, who should you choose?

These three derivatives each have strengths. Options are complex to understand and respond slowly to small changes in the underlying asset. If you want to capture short-term narrow-range opportunities and can tolerate risk, futures or CFDs might be more suitable.

Final words

Options are powerful tools, but they can also hurt you easily. Mastering how to play options is just the first step; the real test is disciplined execution—controlling risks, diversifying investments, and setting proper stop-losses. And don’t forget, even the best tools only make money when your judgment is correct. So, doing thorough research is always the safest investment habit.