What Is an Option? Options Trading Explained
An option is a contract that gives you the right — but not the obligation — to buy or sell 100 shares of a stock at a fixed price before a set date. That single idea, the right without the obligation, is what makes options so flexible: you can bet on direction, generate income, or protect a portfolio, all with risk you define up front.
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Calls and puts: the two building blocks
There are only two kinds of option. A call gives you the right to buy the stock at the strike price; you buy calls when you expect the price to rise. A put gives you the right to sell at the strike; you buy puts when you expect a fall or want to protect shares you own.
Each contract represents 100 shares. You can be the buyer (paying a premium for the right) or the seller/writer (collecting the premium and taking on the obligation). Combining long and short calls and puts builds every strategy that exists.
The four terms you must know
Strike price: the fixed price at which the option can be exercised. Premium: the price you pay or receive for the contract. Expiration: the date the option ends. Underlying: the stock or index the option is based on.
Two more shape an option’s price: intrinsic value (how far in-the-money it already is) and extrinsic value (the time-and-volatility premium on top), which decays to zero by expiration.
Why people trade options
Leverage: one contract controls 100 shares for a fraction of the cost. Income: selling options (covered calls, cash-secured puts) collects premium. Hedging: a put acts like insurance on a stock position.
The key advantage over buying stock is defined risk — when you buy an option, the most you can lose is the premium, no matter how far the stock moves against you.
- An option is the right, not the obligation, to buy (call) or sell (put) at a strike.
- One contract = 100 shares; you can buy options or sell (write) them.
- Know the four terms: strike, premium, expiration, underlying.
- Buyers have defined risk (the premium); options offer leverage, income and hedging.
Frequently asked questions
What is the difference between a call and a put?
A call is the right to buy at the strike (bullish); a put is the right to sell at the strike (bearish or for protection).
Can I lose more than I invest in an option?
Not if you buy options — your maximum loss is the premium paid. Selling uncovered (naked) options is where larger losses can occur.
Do I have to exercise an option?
No. Most traders simply buy and sell the contract itself for its market value before expiration rather than exercising it.
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