An options contract is a legal agreement between two parties: the buyer and the seller. The buyer pays an amount called the premium (Premium) in exchange for (the right, not the obligation) to buy or sell 100 shares at a set price called the strike price (Strike Price), before a set date known as the expiration date (Expiration Date).
Two main types:
- Call option (Call Option): gives you the right to buy 100 shares. It profits when the stock rises.
- Put option (Put Option): gives you the right to sell 100 shares. It profits when the stock falls.
Worked example (1): Call option
Suppose you expect Apple (AAPL) to rise:
| Apple stock (AAPL) | Currently trading at $185 |
|---|---|
| You buy a call with a $190 strike | You pay a premium of $2.50 = $250 in total per contract |
| If AAPL reaches $200 at expiration | Your profit: (200 − 190 − 2.50) × 100 = $750 |
| If the stock stays below $190 | Your loss: only $250 (the premium paid), and the contract expires worthless |
Worked example (2): Put option
Now suppose you expect Tesla (TSLA) to fall:
| Tesla stock (TSLA) | Currently trading at $200 |
|---|---|
| You buy a put with a $190 strike | You pay a premium of $3 = $300 in total per contract |
| If TSLA falls to $170 at expiration | Your profit: (190 − 170 − 3) × 100 = $1,700 |
| If the stock stays above $190 | Your loss: only $300 (the premium paid), and the contract expires worthless |
The difference between buyer and seller (rights versus obligations)
In the options market, every trade has two sides. It is important to understand each side's role so you don't mix them up:
| Party to the contract | Role in the trade | Rights and obligations | Risk and profit |
|---|---|---|---|
| Buyer (Buyer / Holder) | Pays the premium (Premium) upfront to get the contract. | They have the full right to exercise, with no obligation. | Loss is limited to the premium paid, while the potential gain is theoretically unlimited. |
| Seller (Seller / Writer) | Receives the premium (Premium) immediately for creating the contract. | They have a legal obligation to deliver if the buyer decides to use the right. | Its maximum profit is the premium received, and its risk is very high (it can be unlimited). |
A standard options contract always represents 100 shares. A premium of $3 in the market = an actual cost of $300.
Options are leveraged instruments. Gains or losses can be many times those of owning the stock directly. Understand them fully before you trade.
💡 How do traders actually make money?
Many beginners think they must wait until the expiration date to exercise the contract and actually buy the shares. In practice, more than 95% of traders never exercise their contracts at all.
- Instead, traders simply "close the trade" before the expiration date.
- If the contract's value (the premium) rises in the market because the stock moved your way, you can sell the contract itself to another trader and take the price difference as profit. You don't need to own the shares or have enough cash to buy them.
What next?
Now that you know the basics of options and the difference between a call and a put, the next chapter covers the three best-known ideas in option pricing: In The Money, At The Money, and Out of The Money, and how to choose the right strike price for your trade.
