To The Moon

Earnings season is one of the most anticipated periods during the financial year for the market. Investors should know what to expect, but also undertake their own research and analysis to find opportunities that may arise during this time.

Historically, earnings announcements have played a prominent role in moving stocks. As a result, they represent the understanding of a company's position in the unknown future in the world of investing. While projections and expectations are effective tools in modelling the direction and magnitude of equity plays, the world of options opens a plethora of opportunities based on trading volatility. Knowing when to capitalise on mispriced options can yield some great returns.

Learning more about what options are, their benefits, and how you can invest in them will help expand your portfolio and also assist you in finding greater opportunities in your investment journey.

1. What are options?​

An option is a right to buy or sell a certain amount of an asset at a specific price and at a specific time in the future. What does it mean? Let's ask a question first:

If you think a stock is bound to rise in the future, but you don't have enough money, how can you seize this opportunity?

Simple! Let's start with an example:

Jack looked at a $1 million house that was for sale, but now he has no money. He wants to buy it after a month, but he is afraid that the price of the house will rise after a month. So now, Jack faces two choices:

1.One month later, regardless of the rise or fall of house prices, he buys it according to the latest market price;

Or,

2.Spend $10,000 to buy a subscription certificate in the sales department; (the subscription certificate gives Jack the right to buy the house for $1 million after a month, regardless of the rise or fall of the house price).

If this were a situation faced by you, what would you do? It's actually quite simple!

Let's look at how to use options thinking to solve investment problems.

Jack believes that the probability of house prices rising after one month is relatively large, so he chose the second one, and a month later, the house price rises to $1.02 million. Jack exercised his right to buy a house at a price of $1 million, excluding the subscription certificate fee, making a net profit of $10,000 (102-100-1=1). However, think about this, what will Jack do if the house price falls to $980,000 a month later?

The answer is that Jack will not exercise his power, because if he can buy a house directly at the market price of $980,000, why should he buy it at $1 million with a subscription certificate?

For Jack, the only loss is the subscription certificate fee of $10,000, and he forfeits his rights to the option of purchasing the house at the agreed price.

Therefore, the warrant itself is an option, a right rather than an obligation, and you can choose to exercise or not exercise the right after buying a warrant.

The question arises again, what if, after a month, Jack still doesn't have the money to buy a house, but the house price has risen to $ 1.1 million, and Jack doesn't want to give up his position to exercise his contract and lose money?

Very simply, Jack can sell the subscription certificate to other buyers, because whoever has the subscription certificate means they can buy a house of $1.1 million for $1 million, so in theory, the subscription certificate can be sold for up to $100,000, and Jack can make a net profit of $90,000 through the transfer of the subscription certificate. Although Jack did not buy a house, he made a profit from rising house prices.

If Jack's $1 million investment bought a stock rather than a house, then the warrant is called an option. The $10,000 spent on purchasing the warrant is called the premium or option premium, and the $1 million purchase price agreed upon in the future is called the exercise price.

2. The benefits of options.​

So in simple terms, the benefits of the existence of options are as follows.

1. Lock in the future transaction price in advance and hedge risks

Just like Jack buying a house, he can't trade now for various reasons, but he is afraid that the price will rise in the future, so he chooses to buy options to lock in the future price first and hedge risks.

      2.Earn leverage with smaller investments of money

As mentioned above, Jack did not actually buy a house, but he also made a profit from the increase in house prices through the transfer of subscription certificates. If it is through the purchase of the house, the house price rises from $ 1 million to $ 1.1 million, with a yield of 10%, but if it is a transfer of the subscription certificate, the investment amount of $10,000 earns $90,000, and the yield is 900%.

      3.Control the maximum loss

If Jack directly spends $1 million to buy a house, if the house price falls in the future, Jack's maximum loss can theoretically reach $1 million (assuming that the maximum fall in house price is 0), but if it is a purchase option, the house price falls, Jack gives up the exercise, then the biggest loss is the cost of the subscription certificate of $10,000. The reason why the option can control the maximum loss is that it is a choice, it is exercised if it is beneficial to itself, and it is not exercised if it is unfavourable to itself, and the maximum loss is the premium.

If Jack already has a house, but is afraid that the price will fall in the future, can he use options to lock in the price? The answer is yes. Whether you are worried about future price increases or future price declines, you can rely on options to lock in the price.

To solve this problem, we must understand the classification of options.

There are two types of options: call and put

• The so-called call option is the possibility to buy an asset at an agreed price in the future, for example, Tesla's stock call option strike price is $100 and the premium is $10. This means that you can buy this option for $10, and thus have the power to buy Tesla stock for $100 in the future. If Tesla's share price exceeds $100 in the future, you can profit from it!

For example, Jack bought the option, and Tesla's stock price rose to $200 in the future, and Jack exercised the option, so he made a profit of $200-$100-$10 = $90

• The so-called put option is that you can sell an asset at an agreed price in the future. For example, Jack has Tesla stock in his hand. The current market price is $100, but Jack is worried that Tesla's stock price will fall in the future, so buy a put option with a strike price of $100, a premium of $10, then in the future, if Tesla's stock price falls to $90, Jack can still sell his stock at $100.

Of course, as previously mentioned, options not only have the benefit of locking in the asset price, but can also obtain the benefit of rising prices by using leverage.

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