What is an option
An option is a contract. It gives the owner of the option the right, but not the obligation, to buy or sell a fixed amount of an underlying asset at a predetermined price on or before a predetermined date at which point the option expires. That single sentence contains everything — the rest is detail.
There are two types of options. A call option gives the owner of the option the right to buy the underlying asset at the predetermined price. A put option gives the owner of the option the right to sell the underlying at the predetermined price. That predetermined price is the strike price, often called the exercise price. The date at which the option expires is the expiration date.
The buyer of the option will pay the seller of the option for the right inherent in the option. The amount paid for the option is the premium and it is quoted per share of the underlying. In U.S. equity and ETF options, one option contract controls 100 shares of the stock or ETF, so a premium quoted at $2.00 costs a total of $200 to buy.
Rights and obligations
The key asymmetry is between the buyer and the seller. The buyer (the owner) holds a right and can walk away if it is worthless — the most they can lose is the premium they paid. The seller (or “writer”) took the premium up front and has taken on an obligation: if the buyer exercises, the seller must deliver. That is why selling options carries different, sometimes much larger, risk than buying them.
A stock trades at $100. You buy one 30-day $105 call for a $2.00 premium ($200 total). You now have the right to buy 100 shares at $105 any time before expiration. If the stock finishes at $115, your right to buy at $105 is worth $10/share — $1,000 — against the $200 you paid. If the stock finishes below $105, the right is worthless and you simply lose the $200. Your loss is capped; your upside is not.
Why options exist
Several motives drive option trading. Hedging: a put option is insurance — it pays the owner when the underlying falls in price, protecting a portfolio. Leverage: options allow a trader to take a leveraged view on direction or on volatility. Income: options allow an option seller to earn premium for providing leverage or protection to others. This occurs when an investor sells a covered call or a cash-secured put. The same option contract can be a hedge or provide leverage or generate income to one party and be another of those three to the other party.
Importantly, an option — or an option combined with a position in the underlying — can result in a payoff profile that is not just “more” than a position in the underlying alone but “different and better” than a position in the underlying alone. This is the real power of options.
Common pitfalls
Thinking a call is just “cheap stock.” An option expires. Unlike shares, it can go to zero purely because time ran out, even if you were right about direction but too early.
Forgetting the 100× multiplier. A premium that looks like $2 is $200 per contract. Position sizing in options is easy to get wrong by a factor of 100.
Assuming selling is symmetric to buying. A buyer risks a known premium; an uncovered seller can face far larger losses. Rights and obligations are not the same trade.
What to do with this
Anchor on the one sentence: a right, not an obligation, to buy (call) or sell (put) at a set strike by a set date, for a premium, on 100 shares. Every strategy in this Learning Center is built by combining calls and puts, bought and sold, at different strikes and dates. The next lesson makes the buyer/seller split concrete with the four positions everything else is made of.
Next lesson · continue the courseLong vs. short: the four basic positions →
Once options make sense, Volatility 101 shows you how to read what the options market is actually pricing — free, in six short lessons.