Options
An option gives its buyer the right, but not the obligation, to buy (a call) or sell (a put) an asset at a set price until or on a set date.
An option is a contract that gives you a choice. A call lets you buy something at a fixed price before a deadline; a put lets you sell at a fixed price.1 You pay a premium for that choice, and if the market does not go your way, you can simply let the option expire — losing the premium, but nothing more. Sellers of options take the other side and can face much larger losses. This entry explains the vocabulary, the break-even maths and the main risks, using the SEC’s own worked example.
- Category
- Derivatives
- Reading time
- 6 min
- Also called
- Option, Call option, Put option
- Updated
Options in plain words
Options are contracts that give the owner the right to buy or sell an underlying asset at a fixed price on or before a specified future date.2 A call is the right to buy; a put is the right to sell. The fixed price is the strike, the deadline is the expiration, and the price of the option itself is the premium.2
A standard US stock option generally covers 100 shares, so a premium quoted at $2.20 costs $220 per contract. The premium is paid up front to the seller and is not refunded.2
How to read and trade a basic option, step by step
Read the quote
“ABC December 70 Call $2.20” means: underlying ABC, expiring in December, strike $70, a call, premium $2.20 per share.2
Check moneyness
A call is in the money when the stock price is above the strike; a put when the stock price is below the strike. At the money means strike and price are equal.2
Work out the break-even
For a bought call, strike + premium; for a bought put, strike − premium. With a $70 strike and $2.20 premium: $72.20 and $67.80.2
Know what drives the premium
The stock price relative to the strike, the time left until expiration, and the volatility of the stock.2 See Implied Volatility.
Decide how to exit
You can sell the option to close, exercise it, or let it expire. If it expires out of the money, it is worthless.2
Understand the seller’s side
The writer of an option must fulfil the contract if assigned; some option sales expose writers to unlimited losses.2
Worked examples
Example 1 — A call that works
CallABC trades at $68. You buy one December 70 call for $2.20 ($220). Two weeks later ABC is $80 and the option’s premium is $10.20.
| Option value now | $10.20 × 100 = $1,020 |
| Paid | $220 |
| Profit if sold | +$800 |
| Return on premium | ≈ +364% |
This follows the SEC’s worked example.2 A 17.6% rise in the stock produced a 364% gain on the option — leverage works both ways.
Example 2 — The same call expires worthless
ExpiredInstead of selling, you hold to expiration. ABC falls back to $65 on the last day.
| Stock vs. strike | $65 < $70 — out of the money |
| Option value at expiry | $0 |
| Loss | −$220 (the whole premium) |
The option expired worthless, so the full premium was lost.2 The stock fell only from $68 to $65; the option lost everything.
Example 3 — A put as protection
HedgeYou own 100 ABC shares at $72 and buy one December 70 put for $2.20 ($220). ABC drops to $60.
| Loss on the shares | 100 × −$12 = −$1,200 |
| Put value (strike − price) | ($70 − $60) × 100 = +$1,000 |
| Net, including the $220 premium | −$420 |
Without the put, the loss would have been $1,200. The put capped it — at the cost of the premium, which is lost if the stock does not fall. See Hedging.
Profit at expiry: bought call and bought put
The four basic option positions
| Aspect | You expect | Maximum loss | Maximum gain |
|---|---|---|---|
| Buy a call | Price to rise | Premium paid2 | Large; rises with the stock |
| Buy a put | Price to fall | Premium paid2 | Large; up to strike − premium |
| Sell (write) a call | Price not to rise much | Unlimited if uncovered2 | Premium received |
| Sell (write) a put | Price not to fall much | Large; up to strike − premium | Premium received |
Why traders use options
Leveraged directional bets
A small premium gives exposure to 100 shares, with the loss limited to the premium. See Leverage.
Protection
Buying puts against shares you own caps the loss in a fall. See Hedging.
Income
Selling options collects premiums, at the cost of taking on the obligation — and risk — of the other side.
Trading volatility
Option prices reflect expected volatility, so options can be used to trade changes in it. See Volatility.
Advantages and disadvantages
Advantages
- Buyers’ losses are limited to the premium paid.
- Large exposure for a small upfront cost.
- Flexible: can express views on direction, timing and volatility, or protect existing positions.
Disadvantages
- Options lose value as expiration approaches; being right too late still loses.
- Many bought options expire worthless.
- Option writers can face unlimited losses.2
- Pricing depends on volatility and time, which beginners often misjudge.
Going deeper
Read as far as you need. Each level builds on the one before it.
Right vs. obligation
Beginner
The buyer has a right; the seller has an obligation. When a buyer exercises, the seller receives an assignment and must buy or sell the shares at the strike.2
Intrinsic and time value
Intermediate
An option’s premium has two parts: intrinsic value (how far it is in the money) and time value (what traders pay for the chance of more). Time value shrinks as expiration approaches, faster near the end. See Intrinsic Value and Time Value.
The Greeks
Advanced
Option traders measure sensitivity with the Greeks: delta (to the stock price), gamma (how delta changes), theta (to time), vega (to volatility) and rho (to interest rates). They explain why an option can lose money even when the stock moves the right way. See Option Greeks.
Standard US stock options generally expire on a set monthly cycle, but weekly, quarterly and other expirations also exist; check the exact date with your broker.2
Common mistakes
Buying cheap, far out-of-the-money options
Low premiums reflect low odds; most such options expire worthless.
Forgetting the break-even
The stock must move past strike plus (or minus) the premium before a held-to-expiry option profits.
Ignoring time decay
Holding and hoping costs time value every day.
Selling options without understanding the risk
Writing uncovered calls can lose far more than the premium received.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- A call is the right to buy, a put the right to sell, at the strike price until expiration.
- One standard US stock option generally covers 100 shares; the premium is paid up front.
- Break-even: strike + premium for calls, strike − premium for puts.
- Buyers can lose at most the premium; writers can lose much more.
- Time and volatility drive option prices as much as direction does.
Frequently asked questions
Can I lose more than I paid for an option?
Do I have to exercise an option?
Why did my option lose value when the stock went up?
Further learning
- Volatility
What option premiums are really pricing.
- Leverage
Why small premiums can mean big percentage swings.
- Futures Contract
The other main exchange-traded derivative.
- Short Selling
Another way to profit from falling prices, with different risks.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- FINRA. Options (opens in a new tab) Checked .
- Investor.gov (SEC). An Introduction to Options – Investor Bulletin (opens in a new tab) Checked .
Read more elsewhere
- Investopedia: Option (opens in a new tab)
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.