Options 101 · Module 1 of 10
What an option is
In this lesson
Define an option contract, who holds the right vs the obligation, the 100-share multiplier, strike, expiration, premium, and American vs European style.
- 5
- short parts
- 12
- questions
- ~15
- minutes
Read the whole lesson on one page
What an option is: the lesson
An option is a contract with a price tag
A stock trades at $50. For $30, you can buy a contract that lets you buy 100 shares at $55 at any time over the next 30 days. You don't have to use it.
If the stock stays at $50, you walk away and you're out $30. If it jumps to $60, your right to buy at $55 is worth real money. That contract is a call option.
Four words you need
- Strike: the fixed price written in the contract. Here, $55.
- Expiration: the last day the right exists.
- Premium: the price of the contract, quoted per share. A quote of 0.30 means 30 cents a share.
- Contract size: one standard US equity option covers 100 shares.
- Step 1: Read the quote: 0.30 a share.
- Step 2: Multiply by the 100 shares: 0.30 × 100 = $30.
- Step 3: That $30 is the most the buyer can lose.
| Call | Strike | Put |
|---|---|---|
| 5.22 | 45 | 0.22 |
| 1.72 | 50 | 1.72 |
| 0.30 | 55 | 5.30 |
Stock at $50. Shaded prices are in the money; the outlined row is at the money.
Illustrative numbers, not real quotes.
Calls and puts
| Call | Put |
|---|---|
| The right to buy 100 shares at the strike | The right to sell 100 shares at the strike |
| Gains when the stock rises | Gains when the stock falls |
| The seller must sell if assigned | The seller must buy if assigned |
The chart shows profit or loss at expiration for each stock price. This is the buyer of the 55 call from the last section. Between 55 and 55.30 the call is worth something, so you would exercise it, but you still lose money overall because you paid more than it returns.
Stock at $60.00: profit of $470
- Breakeven
- 55.30
- Max loss
- $30
Two sides of every trade
| Buyer | Seller (also called the writer) |
|---|---|
| Pays the premium | Receives the premium |
| Has the right | Has the obligation |
| Can lose at most the premium | Can lose much more than the premium |
Why would anyone take the obligation? They're paid up front. The seller of the 55 call keeps the $30 if the stock stays below $55.
A put seller agrees to buy 100 shares at the strike if assigned. Sell a 25 put for 0.60 and the stock falls to $20: you buy $2,000 of stock for $2,500, less the $60 you collected. That's a $440 loss.
Stock at $60.00: loss of $470
- Breakeven
- 55.30
- Max gain
- $30
An option isn't a share
An option is a contract about shares, not ownership. A call holder gets no vote and no dividends unless they exercise and take the shares.
Worked example: One call, both sides
Illustrative numbers, not real quotes.
Stock XYZ is at $50. The XYZ 55 call, expiring in 30 days, is quoted at 0.30.
- The buyer pays 0.30 × 100 = $30 and gets the right to buy 100 XYZ at $55 until expiration.
- The seller receives $30 and must sell 100 XYZ at $55 if assigned.
- Both sides know their numbers on day one: the buyer can lose at most $30, and the seller can make at most $30.
Here is what each side has at expiration, per contract, for different XYZ prices:
| XYZ at expiration | Call is worth | Buyer P&L | Seller P&L |
|---|---|---|---|
| $50 | $0 | −$30 | +$30 |
| $55 | $0 | −$30 | +$30 |
| $55.30 | $30 | $0 | $0 |
| $58 | $300 | +$270 | −$270 |
| $60 | $500 | +$470 | −$470 |
- At $55.30 the buyer breaks even: the call is worth the $30 paid.
- Above that, the seller loses what the buyer gains. A seller who doesn't own the shares can lose more if the stock keeps climbing.
Education only, not investment advice. Options involve risk. Read the OCC's Characteristics and Risks of Standardized Options. Example numbers are illustrative.