Options

Options are powerful and flexible financial tools that traders use to hedge risk, generate income, or speculate on market movements. For example, one type of option lets you benefit from a rising market with limited downside risk, while another can protect your portfolio from falling prices.

In this guide, we’ll walk through what options are, how they work, and the key concepts every trader should understand before diving into options trading.

What Is an Option?

An option is a contract that gives the buyer the right — but not the obligation — to buy or sell an underlying asset at a set price (called the strike price ) on or before a specific date (expiration date ). The underlying asset could be a stock, bond, commodity, index, currency, or other financial instruments.

There are two basic types of options:

Call Option : Gives the buyer the right to buy the asset at the strike price before expiration.

Put Option : Gives the buyer the right to sell the asset at the strike price before expiration.

Traders usually buy call options when they expect the asset’s price to go up, and put options when they think it will fall.

Call Option Explained

A call option allows the buyer to purchase an asset at a fixed price before the option expires. If you believe the price of the asset will rise, buying a call option can be a smart move.

For example, suppose today is April 1st, and Company XYZ is currently trading at $50 per share. You think the price will go up in the next two months, so you decide to buy a call option with a strike price of $55 , expiring on June 1st , for a premium of $2 per share . Since each contract covers 100 shares, the total cost is $200 .

Here's what can happen:

Scenario 1 – Stock Price Rises Above Strike

By May 20th, the stock jumps to $65 per share . Your option is now “in-the-money.” You can exercise the contract and buy the shares at $55 , then immediately sell them at the current market price of $65 , making a $10 profit per share . After subtracting the $2 premium , your net gain is $8 per share , or $800 total .

Scenario 2 – Stock Price Falls Short

On June 1st, the stock only reaches $53 , below the strike price of $55 . In this case, the option becomes worthless. You don’t exercise it and your loss is limited to the $200 premium you paid.

As you can see, call options offer the chance to profit from upward moves while capping your potential losses.

Put Option Explained

A put option gives the buyer the right to sell an asset at a set strike price before expiration. Investors often buy puts to profit from falling prices or to protect their portfolios from downward moves.

Let’s say it’s October 1st, and shares of Company ABC are trading at $80 . You expect a drop in value and decide to buy a put option with a strike price of $75 , expiring on January 1st , for a $3 per share premium . This makes the total investment $300 .

Here's how it plays out:

Scenario 1 – Stock Price Drops Below Strike

By December 15th, the stock falls to $65 per share . Your put option is now “in-the-money,” meaning you can sell the stock at $75 , even though the market price is much lower. After deducting the original $3 premium , you make a net $7 per share , totaling $700 for 100 shares.

Scenario 2 – Stock Price Stays Above Strike

On January 1st, the stock is at $77 , still above the $75 strike . The put option has no value, and you choose not to exercise it. Your total loss is the $300 premium you paid.

Buying put options is a way to profit from declining markets while keeping your risk capped at the initial investment.

Who Are Option Writers?

The people who sell options are known as option writers or sellers. They receive the premium upfront but take on the obligation to honor the contract if the buyer chooses to exercise the option.

If you sell a call option , you must sell the asset at the strike price if exercised.

If you sell a put option , you must buy the asset at the strike price if the buyer decides to exercise.

This role comes with more risk than buying options, as the seller may have to fulfill the terms regardless of market conditions.

Example #3: Selling a Call Option

Let’s look at a real-world example of writing a call option.

You own 100 shares of Company GHI , which is currently priced at $40 per share . You think the stock will stay flat or rise slightly over the next month, so you decide to sell a call option .

You find a call with a strike price of $45 , expiring on July 1st , and collect a $1.50 per share premium , giving you $150 total .

Scenario 1 – Stock Stays Below Strike

On July 1st, the stock is at $43 — still under the strike price. The buyer doesn’t exercise the option, and you keep the full $150 premium as profit. You also retain your 100 shares.

Scenario 2 – Stock Surpasses Strike

On July 1st, the stock rises to $47 . The buyer exercises the option, and you must sell your 100 shares at $45 , receiving $4,500 .

Your effective selling price becomes $46.50 per share — because you collected $1.50 per share in premiums . Even though the stock went higher after you sold the option, you still made a solid return by collecting the premium.

Selling covered calls is a popular strategy for generating extra income from long-term holdings, although it limits upside potential if the stock surges beyond expectations.

Example #4: Selling a Put Option

Now let’s look at how writing put options works.

Company DEF is trading at $120 per share , and you believe the price will either rise or remain stable over the next few months. To earn some income, you decide to sell a put option with a strike price of $115 , expiring on October 1st , for a $4 per share premium . That means you get $400 upfront for taking the risk.

Scenario 1 – Stock Holds Up

On October 1st, the stock is at $125 — well above the strike price. The put option expires “out-of-the-money,” and you keep the $400 as pure profit. No further action is needed.

Scenario 2 – Stock Falls Below Strike

On October 1st, the stock drops to $110 — below the $115 strike . The buyer exercises the option, and you’re required to buy 100 shares at $115 , or $11,500 total . Since the stock is now worth $110 , you effectively paid $5 more per share than market value . However, you received the $4 premium , so your net loss is $1 per share , or $100 total .

Selling put options can be profitable in stable or rising markets, but it carries the risk of being forced to buy the stock at a higher-than-market price if the market turns against you.

Key Components of an Option

To trade options successfully, it’s important to understand the core elements of any contract:

Strike Price : The price at which the underlying asset can be bought or sold.

Expiration Date : The last day the option remains valid. After this date, the option either expires worthless or is settled.

Premium : The amount paid (for buyers) or received (for sellers) to enter the contract. It’s influenced by time until expiry, volatility, and how far the strike price is from the current market price.

Intrinsic Value : The difference between the current market price and the strike price. If the option has value right now, it's called “in-the-money.”

Time Value : Part of the premium that reflects how much time is left before the option expires. As expiration nears, the time value declines — a process known as time decay .

These factors together determine whether an option is valuable, and how much risk is involved.

Exercising an Option

When a buyer decides to use their right to buy or sell the asset, they "exercise" the option. Their broker handles the transaction, and the seller (or writer) must fulfill the contract.

Stock options typically allow for either physical delivery of shares or cash settlement, depending on the contract structure and brokerage rules.