An option is a contract that gives you the right, but not the obligation, to buy or sell a stock at a set price before a set date. Options are flexible, but they also lose value over time, which is why many beginners lose money even when they guess the direction correctly.
The key terms
| Term | Meaning |
|---|---|
| Call option | The right to buy the stock at the strike price |
| Put option | The right to sell the stock at the strike price |
| Strike price | The price at which you can buy or sell |
| Expiration | The last date the option is valid |
| Premium | The price you pay for the option |
| Contract size | A standard US stock option covers 100 shares |
A simple call example
Say a stock trades at $50. You buy one call with a $55 strike that expires in two months, for a premium of $2 per share. Because one contract covers 100 shares, you pay $200.
- If the stock rises to $60 at expiration, the option is worth $5 per share ($500). Your profit is $500 − $200 = $300.
- If the stock stays at or below $55, the option expires worthless and you lose the full $200.
Your break-even at expiration is the strike plus the premium: $55 + $2 = $57.
What moves an option’s price?
- The stock price. Calls gain when the stock rises; puts gain when it falls.
- Time. Options lose value as expiration gets closer. This is called time decay.
- Volatility. When the market expects bigger moves, options get more expensive. After big events like earnings, that extra value often drops quickly.
Buying vs selling options
Buying options Risk is limited
The most you can lose is the premium you paid. The trade-off is that you need the stock to move enough, and soon enough, to beat time decay.
Selling options Higher risk
You collect the premium up front, and time decay works in your favour. But the risk can be much larger than the premium. Selling a call without owning the shares (a “naked” call) has theoretically unlimited risk. Covered calls and cash-secured puts are more conservative ways to sell options.
Conclusion
Options are a tool, not a shortcut to quick money. Learn the terms above, start with small defined-risk trades, and pair every trade with a clear risk plan.
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