What an options contract actually is
An option is a contract that gives you the right—but not the obligation—to buy or sell a specific stock at a set price by a certain date. You do not have to exercise that right. You pay a smaller amount upfront, called the premium, to hold that contract. The person selling you the option collects that premium whether you use the contract or not.
There are two types. A call option gives you the right to buy a stock at a fixed price. A put option gives you the right to sell a stock at a fixed price. The fixed price is called the strike price. The date by which you must decide is called the expiration date.
Example: You buy a call option on Apple stock with a strike price of $150 and an expiration date three months away. You pay $5 per share for that contract (the premium). If Apple's stock rises to $160 before expiration, you can exercise your option, buy the stock at $150, and immediately sell it at $160—keeping the $10 difference minus the $5 premium you paid. If Apple stays below $150, you let the contract expire and lose only the $5 premium.
Key Takeaways
- An option contract costs less upfront than buying the stock itself, because you are paying only for the right to buy or sell, not the stock itself.
- Call options profit when the stock price rises; put options profit when the stock price falls.
- The premium is the price you pay to hold the contract; the strike price is the price at which you can buy or sell if you exercise the option.
- Options expire on a set date, and after that date the contract is worthless if you have not used it.
- You can sell an option contract to someone else before expiration instead of exercising it yourself.
How the premium price changes before expiration
The premium you pay for an option is not fixed. It changes every trading day based on the stock's current price, how much time is left until expiration, and how much the stock price is expected to move. If a stock rises, call option premiums rise and put option premiums fall. If a stock falls, the opposite happens.
Time also matters. As expiration gets closer, the premium usually shrinks because there is less time for the stock to move in your favor. This works against you if you hold the contract—your option loses value just by waiting. It works for you if you sold the option to someone else, because you keep the premium and the contract becomes worthless.
Volatility—how much a stock's price swings—also changes the premium. A stock expected to move wildly has higher option premiums because there is more chance the option will end up valuable. A stock that barely moves has lower premiums.
Call options: buying the right to purchase
When you buy a call option, you are betting the stock price will rise above the strike price before expiration. You pay the premium upfront. If the stock rises above the strike price, the option is in the money—it has real value. If the stock stays below the strike price, the option is out of the money—it has no value at expiration.
You have three choices when a call option is in the money: exercise it (buy the stock at the strike price), sell the contract to someone else for a profit, or hold it and hope the stock rises more. Most traders sell the contract rather than exercise it, because selling is faster and you do not need the cash to buy 100 shares of stock.
The maximum you can lose on a call option is the premium you paid. The maximum you can gain is theoretically unlimited, because a stock price can rise indefinitely. This is why call options appeal to traders who expect a stock to jump but do not want to risk buying the stock outright.
Put options: buying the right to sell
When you buy a put option, you are betting the stock price will fall below the strike price before expiration. You pay the premium upfront. If the stock falls below the strike price, the put is in the money. If the stock stays above the strike price, the put is out of the money and worthless at expiration.
Put options are often used as insurance. If you own 100 shares of a stock you believe in long-term but worry it might drop in the next few months, you can buy a put option. If the stock crashes, your put option gains value and offsets your loss. If the stock rises, you lose the premium but your shares gain value instead.
Like calls, you can exercise a put (sell the stock at the strike price), sell the contract to someone else, or hold it. The maximum you can lose is the premium. The maximum you can gain is the strike price minus the premium, because a stock cannot fall below zero.
What happens at expiration
On the expiration date, the option contract stops existing. If it is in the money, it is automatically exercised—you buy the stock (for a call) or sell the stock (for a put) at the strike price. If it is out of the money, it simply expires worthless and you lose the premium you paid.
Most brokers will automatically exercise an in-the-money option for you unless you tell them not to. This can be a problem if you do not have the cash to buy 100 shares (for a call) or do not own the shares to sell (for a put). Check your broker's rules before expiration arrives. Some brokers will sell the contract for you automatically if you do not have the resources to exercise it.
Expiration dates vary. Most options expire on the third Friday of each month, but some expire weekly or daily. Shorter expiration dates mean the premium decays faster, so the time pressure is higher.
Selling options instead of buying them
You can also be the seller in an options contract. When you sell a call option, you collect the premium upfront and take on the obligation to sell the stock at the strike price if the buyer exercises. When you sell a put option, you collect the premium and take on the obligation to buy the stock at the strike price if the buyer exercises.
Selling options is riskier than buying them because your potential loss is much larger. If you sell a call on a stock that skyrockets, you are forced to sell it at the strike price and miss out on all the gains above that price. If you sell a put on a stock that crashes, you are forced to buy it at the strike price even though it is now worth much less.
Most brokers require you to have significant cash or holdings in your account before they allow you to sell options. They want to know you can actually deliver on your obligation if the option is exercised.
How to read an options chain
An options chain is a table showing all available options for a stock. It lists strike prices down the left side, with call options on the left half and put options on the right half. For each strike price, you see the current premium, how many contracts have traded that day, and how much the premium has moved.
The columns typically show: strike price, bid (the highest price a buyer will pay right now), ask (the lowest price a seller will accept), last trade price, volume (number of contracts traded), and open interest (total contracts still open). The bid-ask spread—the gap between bid and ask—tells you how easy it is to buy or sell that contract. A wide spread means fewer traders are interested and you might have trouble getting a good price.
Options closer to the current stock price have higher premiums and tighter bid-ask spreads because more traders are interested. Options far from the current stock price are cheaper but harder to trade and less likely to end up in the money.
Frequently Asked Questions
What does "in the money" and "out of the money" mean?
In the money means the option has real value if exercised right now. For a call, the stock price is above the strike price. For a put, the stock price is below the strike price. Out of the money means the option has no value if exercised immediately—the stock price is below the strike for a call, or above the strike for a put.
Can I lose more than the premium I paid?
If you only buy options, no—your maximum loss is the premium. If you sell options, yes—your loss can be much larger because you are obligated to buy or sell the stock at the strike price no matter how far the price moves against you.
What is the difference between American and European options?
American options can be exercised any time before expiration. European options can only be exercised on the expiration date itself. Most stock options traded in the U.S. are American. European options are less common but sometimes cheaper because the seller has less risk.
Do I need to own the stock to buy a put option?
No. You can buy a put on any stock whether you own it or not. If you own the stock, the put acts as insurance. If you do not own it, you are betting the stock will fall. If it does and you exercise, you will need the cash to buy the stock at the strike price.
How much does it cost to buy one option contract?
Option premiums are quoted per share, but one contract controls 100 shares. If a premium is listed as $2, you pay $200 to buy one contract ($2 × 100 shares). This is still much cheaper than buying 100 shares of the stock itself.