Options basics¶
This page is only about how options work. We will not optimize risk yet. First understand the contracts; later pages compare ways to control loss.
Not financial advice
Educational material only. Read your broker’s options risk disclosure before trading.
What an option is¶
An option is a contract about a stock (or ETF) at a strike price by an expiration date.
- A call gives the holder the right to buy 100 shares (typical equity contract) at the strike.
- A put gives the holder the right to sell 100 shares at the strike.
Someone must be on the other side. If you buy the option, you pay a premium. If you sell (write) the option, you receive the premium and take on an obligation if the buyer exercises.
Four building blocks¶
Every options position is one of these, or a combination of them:
| Position | You… | You want… | Rough loss shape |
|---|---|---|---|
| Long call | Pay premium | Stock up strongly | Limited to premium paid |
| Long put | Pay premium | Stock down strongly | Limited to premium paid |
| Short call | Collect premium | Stock flat or down | Can be very large if stock rips higher |
| Short put | Collect premium | Stock flat or up | Large if stock crashes (toward zero in theory) |
Later pages show how traders pair legs to change those loss shapes. That is risk design — not required to understand the table above.
Premium, strike, expiration¶
- Premium — the market price of the option. Quoted per share; one contract usually multiplies by 100. A $2.50 premium is about $250 per contract before fees.
- Strike — the contract’s reference price.
- Expiration — when the contract ends. Many U.S. equity options can be exercised early (American style), so short options can be assigned before expiry.
In, at, and out of the money¶
| Term | Call | Put |
|---|---|---|
| ITM (in the money) | Stock above strike | Stock below strike |
| ATM (at the money) | Stock near strike | Stock near strike |
| OTM (out of the money) | Stock below strike | Stock above strike |
OTM options are cheaper because they need a bigger move to become valuable at expiration.
Intrinsic value and time value¶
Premium has two pieces in plain language:
- Intrinsic — value if exercised right now (only ITM options have this).
- Time value — the rest. It tends to shrink as expiration approaches if nothing else changes. That decay is related to theta (see Greeks).
Buyers hope the stock moves enough to overcome time decay. Sellers often hope time decay helps them — which is why selling without a plan for large adverse moves is dangerous.
Long vs short mindset¶
Buying an option is paying for a defined ticket: your loss is usually capped at what you paid.
Selling an option is collecting a premium for taking on an obligation. The premium is your maximum gain on that single short option if it expires worthless. The loss can be much larger than the premium unless you add protection (shares, cash, or another option).
That asymmetry — small credit, larger possible loss on naked shorts — is why the next pages spend time on payoffs and then on risk categories.
What to do next¶
- Single-option payoffs — pictures and formulas for the four building blocks
- Greeks enough to operate
- Weekly vs monthly
- Then Ways to manage risk — before any playbook
Sources¶
- OCC Characteristics and Risks of Standardized Options
- Sources index
Not financial advice. Verify broker rules yourself.