Options Trading Basics
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 can hedge risk or add leverage, and they need careful handling.
Call option
The right to buy a stock at the strike price before expiry. Buyers of calls profit when the stock rises above the strike by more than the premium they paid.
Put option
The right to sell a stock at the strike price before expiry. Buyers of puts profit when the stock falls below the strike by more than the premium. Puts are often used as insurance for stocks you own.
Key terms
| Term | Meaning |
|---|---|
| Strike price | The price at which the option lets you buy (call) or sell (put) |
| Premium | The price you pay to buy the option |
| Expiry | The last date the option can be used |
| Lot size | The number of shares one contract covers |
| In the money | A call with strike below the stock price, or a put with strike above it |
| Out of the money | A call with strike above the stock price, or a put with strike below it |
| Time decay | Options lose value as expiry approaches, all else equal |
| Implied volatility | The market's expectation of future price swings, built into the premium |
Buyer vs seller
- Option buyer: pays the premium; maximum loss is the premium paid.
- Option seller (writer): receives the premium; takes on the obligation, and losses on an uncovered position can be very large.
A simple example
A stock trades at 100. You buy a call with a strike of 105 for a premium of 2 per share.
If the stock is at 112 at expiry, the call is worth 7; your profit is 7 − 2 = 5 per share. If the stock stays below 105, the call expires worthless and you lose the premium of 2.
Common uses
- Protective put: insure a stock you own against a fall
- Covered call: earn premium on shares you already hold
- Directional bet: limited-risk exposure to a big move
Risks to understand first
- Most options bought for speculation expire worthless.
- Time decay works against buyers every day.
- Leverage magnifies losses as well as gains.
- Selling options without owning the shares can cause losses far bigger than the premium received.
Educational information only, not investment advice. Market data may be delayed.
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