Options are contracts that give you the right (but not obligation) to buy or sell a stock at a specific price. They're powerful tools for both speculation and protection—but they come with risks.
Watch Out
Options are complex instruments that can result in significant losses. Only trade options with money you can afford to lose, and ensure you fully understand the risks before trading.
What Is an Option?
An option is a contract with four key components:
- Underlying stock — The stock the option is based on (e.g., Apple, SPY)
- Strike price — The price at which you can buy/sell the stock
- Expiration date — When the contract expires
- Premium — The price you pay (or receive) for the option
The Two Types of Options
Call Options (Bullish)
- Gives you the right to BUY stock at the strike price
- You profit when the stock goes UP
- Buying calls = betting the stock will rise
Put Options (Bearish)
- Gives you the right to SELL stock at the strike price
- You profit when the stock goes DOWN
- Buying puts = betting the stock will fall or protecting gains
Options vs. Stock: A Comparison
| Buying Stock | Buying Call Option | |
|---|---|---|
| Cost | $10,000 (100 shares at $100) | $300 (1 contract) |
| Max loss | $10,000 | $300 (premium paid) |
| Upside | Unlimited | Unlimited (minus premium) |
| Time limit | None | Until expiration |
Pro Tip
Options provide leverage—control of 100 shares for a fraction of the cost. But they can expire worthless, making timing crucial.
Key Terms to Know
Premium
The price of the option. When you buy an option, you pay the premium. When you sell an option, you receive the premium.
Example: A call option with a $3.00 premium costs $300 total (each contract covers 100 shares).
Strike Price
The price at which you can exercise the option.
Example: A $105 strike call gives you the right to buy stock at $105, regardless of the current price.
Expiration Date
Options expire worthless if not exercised or sold. Most expire on the third Friday of each month.
In the Money (ITM) vs. Out of the Money (OTM)
| Option Type | ITM | OTM |
|---|---|---|
| Call | Stock price > Strike price | Stock price < Strike price |
| Put | Stock price < Strike price | Stock price > Strike price |
How Options Make (or Lose) Money
Buying a Call Option: Example
- Stock: XYZ at $100
- You buy: $105 call for $3 premium
- Total cost: $300
Scenarios at expiration:
| Stock Price | Option Value | Profit/Loss |
|---|---|---|
| $95 | $0 (worthless) | -$300 |
| $100 | $0 (worthless) | -$300 |
| $105 | $0 (at breakeven) | -$300 |
| $108 | $300 | $0 (breakeven) |
| $115 | $1,000 | +$700 |
| $120 | $1,500 | +$1,200 |
Breakeven = Strike price + Premium = $105 + $3 = $108
The Greeks: Option Sensitivities
Options prices change based on several factors, measured by "the Greeks":
| Greek | Measures | Impact |
|---|---|---|
| Delta | Price sensitivity | How much option moves per $1 stock move |
| Gamma | Delta's rate of change | How quickly delta changes |
| Theta | Time decay | How much value lost per day |
| Vega | Volatility sensitivity | Impact of volatility changes |
| Rho | Interest rate sensitivity | Impact of rate changes |
Delta Deep Dive
- Call delta: 0 to +1.00 (positive, bullish)
- Put delta: 0 to -1.00 (negative, bearish)
- ATM options have ~0.50 delta
Example: A call with 0.60 delta gains $0.60 when the stock rises $1.
Theta (Time Decay)
Options lose value every day, especially as expiration approaches.
Watch Out
Time decay accelerates in the final 30 days. Buying options with short expirations is extremely risky.
Common Beginner Mistakes
Mistake 1: Buying Way OTM Options
Cheap options are cheap for a reason—they're unlikely to pay off.
Mistake 2: Ignoring Time Decay
Buying weekly options? Theta is your enemy. The stock might move in your direction but not enough to overcome time decay.
Mistake 3: Position Sizing
One contract controls 100 shares. Risking too much on a single trade can devastate your account.
Mistake 4: Not Understanding Max Loss
When buying options, your max loss is the premium paid. When selling options, losses can be unlimited.
Getting Started Safely
- Paper trade first — Practice without real money
- Start small — One contract at a time
- Use longer expirations — 30-90 days gives more time to be right
- Define your risk — Only risk what you can lose
- Learn strategies — See our Options Strategies Guide
The Bottom Line
Options are powerful tools that can enhance returns or protect positions. But they require understanding of how they work, the Greeks, and proper position sizing.
Quick Win
Use our Options Profit Calculator to visualize how different options strategies perform at various stock prices. Understanding the risk/reward before trading is essential.