Options markets for beginners

What an option is

An option is a contract that gives its buyer the right, but not the obligation, to buy or sell an asset at a set price before or on a set date.

• Call: the right to buy at the strike price.
• Put: the right to sell at the strike price.

The buyer pays the seller (the writer) a premium. In the US, one stock option contract usually covers 100 shares.

Key terms

• Strike (exercise) price: the price at which the option can be used.
• Expiration date: the last day the option can be used.
• American option: can be exercised any time before expiration. European option: only at expiration.

Moneyness

What an option is worth

Option price = Intrinsic value + Time value

• Intrinsic value: what you’d get by exercising now. For a call, max(stock − strike, 0).
• Time value: the extra paid for the chance the option becomes more valuable before it expires.

A call’s price rises with a higher stock price, a lower strike, more time to expiration, higher volatility, and higher interest rates. More volatility helps both calls and puts, because the buyer’s loss is capped at the premium while the possible gain grows.

Common uses

• Speculation: buying calls (or puts) to profit from a rise (or fall) with less money up front, but with leverage. See profit and returns on options.
• Protective put: owning a stock plus a put, which sets a floor on your loss, like insurance.
• Covered call: owning a stock and selling a call on it, which earns the premium but caps your upside.

The risks

• Option buyers can lose their entire premium if the option expires worthless.
• Sellers of uncovered calls face potentially unlimited losses.

This lesson is for education only and isn’t investment advice.

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