Stock options give you the right to buy or sell a company's stock at a set price by a certain date, but you don't have to exercise that right

A stock option is a contract between two people: one who owns the right to buy or sell shares at a fixed price, and one who sold that right. When you trade options, you're buying and selling these contracts themselves, not the underlying stock. The contract specifies four things: which stock, what price you can buy or sell it at (called the strike price), when the contract expires, and how many shares it covers (usually 100 per contract).

The person who buys an option pays money upfront, called the premium, for the right to act later. The person who sells the option collects that premium immediately. If the stock price moves in your favor, your option becomes more valuable and you can sell it for a profit, or you can exercise it and buy or sell the actual shares. If the stock price moves against you, your option loses value and you can let it expire worthless—your only loss is the premium you paid.

Key Takeaways

  • A stock option contract gives you the right—but not the obligation—to buy or sell 100 shares of a specific stock at a locked-in price before an expiration date.
  • You pay a premium to buy an option and collect a premium when you sell one; this premium is separate from the stock price itself.
  • Call options let you buy stock at the strike price; put options let you sell stock at the strike price.
  • Options expire on a set date, and after that date the contract is worthless if you haven't exercised it or closed your position.
  • Options trading involves real money risk and moves faster than stock trading, so most brokers require experience or a signed agreement before you can trade them.

Calls and puts: the two types of options

There are only two kinds of options contracts. A call option gives you the right to buy stock at the strike price. A put option gives you the right to sell stock at the strike price. Everything else in options trading is a combination or variation of these two.

If you buy a call option on Apple stock with a strike price of $150 and Apple's stock rises to $160, your option is now worth at least $10 per share (or $1,000 per contract, since one contract covers 100 shares). You can sell that contract to someone else for a profit, or you can exercise it and buy 100 shares of Apple at $150 each, then immediately sell them at $160 each. If Apple's stock falls to $140, your call option expires worthless and you lose only the premium you paid.

If you buy a put option on Apple with a strike price of $150 and Apple's stock falls to $140, your put is now worth at least $10 per share. You can sell the contract for a profit, or exercise it and sell 100 shares at $150 each (even though the market price is $140). If Apple's stock rises to $160, your put expires worthless.

How the premium works and why it changes

The premium is the price you pay to buy an option or receive when you sell one. It is not the same as the strike price. A call option might have a strike price of $150 but a premium of $3 per share ($300 per contract). This means you pay $300 upfront for the right to buy 100 shares at $150 each later.

The premium changes constantly based on how likely the option is to make money by expiration. If the stock price rises, call premiums go up and put premiums go down. If the stock price falls, put premiums go up and call premiums go down. The premium also depends on how much time is left until expiration—options lose value as the expiration date approaches, even if the stock price doesn't move. An option with three months until expiration costs more than an identical option with one week left.

Volatility also affects the premium. If a stock is expected to swing wildly in price, options on that stock cost more because there's a bigger chance the option will end up in the money. If a stock is stable and predictable, options cost less.

What happens when an option expires

Every option contract has an expiration date. For stock options, this is usually the third Friday of the month, though some brokers offer weekly expirations. On the expiration date, the contract simply ceases to exist.

If you own a call option and the stock price is above the strike price at expiration, the option is in the money. Some brokers will automatically exercise it for you (buy the shares at the strike price). If the stock price is below the strike price, the option is out of the money and expires worthless. You lose the premium you paid, but that's your only loss.

If you sold an option and it expires out of the money, you keep the entire premium you collected. If it expires in the money, you may be forced to buy or sell the underlying shares at the strike price, depending on which side of the contract you're on. This is called assignment.

The difference between trading options and owning stock

When you own stock, you own a piece of the company. When you trade options, you own a contract that expires. Stock has no expiration date; options do. This means options are time-sensitive in a way stocks are not. An option that is slightly out of the money can still become profitable if the stock moves before expiration, but once expiration arrives, it's gone.

Options also move faster than stocks. A 1% move in a stock's price can cause a 5% or 10% move in an option's premium, especially for options close to expiration. This means you can make or lose money much faster with options than with stock. You can also control more shares with less money—one option contract controls 100 shares, so a small premium payment gives you exposure to a large amount of stock.

Because of this speed and leverage, most brokers require you to have trading experience or sign an options agreement before you can trade them. Some brokers restrict beginners to buying calls and puts only, not selling them.

Basic strategies: buying versus selling options

The simplest options strategy is buying a call or put. You pay the premium upfront, your maximum loss is that premium, and your profit is unlimited (for calls) or large (for puts). This is straightforward: you're betting the stock will move in a certain direction before expiration.

Selling options is the opposite bet. You collect the premium immediately and hope the option expires worthless so you keep it all. Your maximum profit is the premium you collected, but your loss can be much larger. If you sell a call and the stock price skyrockets, you may be forced to sell shares you don't own at a loss, or buy them at a high price to deliver them. This is called a naked call and carries unlimited risk. Most brokers require significant experience or a large account before allowing naked calls.

More complex strategies combine multiple options—buying a call and selling a call at a higher strike price, for example—to reduce cost or limit risk. These strategies have names like spreads, straddles, and collars, and they're designed for specific market conditions or risk tolerances.

Where options are traded and how to get your free guide

Stock options are traded on exchanges like the Chicago Board Options Exchange (CBOE). You don't trade directly on the exchange; instead, you use a broker. Nearly all major brokers—Fidelity, Charles Schwab, E-Trade, Interactive Brokers, and others—offer options trading to their customers.

To trade options, you'll need to open a brokerage account and request options trading permission. The broker will ask about your investment experience, income, and net worth. They may restrict you to certain strategies based on your answers. Once approved, you can place options orders through the broker's platform just like stock orders. You'll see bid and ask prices for each contract, and you can buy or sell at those prices.

Options trades settle in one business day, meaning the money or shares move the next day. If you exercise an option, the broker handles the mechanics—you don't have to do anything except confirm the exercise.

Frequently Asked Questions

What does "in the money" and "out of the money" mean?

An option is in the money when it would make money if exercised right now. A call is in the money if the stock price is above the strike price. A put is in the money if the stock price is below the strike price. Out of the money is the opposite—the option would lose money if exercised immediately.

Can I lose more money than I paid for the option?

If you buy an option, no—your maximum loss is the premium you paid. If you sell an option, yes, especially if you sell a call without owning the shares. This is why brokers restrict naked call selling to experienced traders.

What happens if I don't close or exercise my option before expiration?

If the option is out of the money, it expires worthless and you lose the premium. If it's in the money, most brokers automatically exercise it for you, meaning you'll buy or sell the shares at the strike price. Check your broker's policy on automatic exercise.

How do I know what strike price and expiration date to choose?

Strike price depends on your outlook: higher strikes for calls if you're mildly bullish, lower strikes if you're very bullish. Expiration depends on your timeline—longer expirations cost more but give you more time to be right. Most beginners start with expirations one to three months out.

Is options trading the same as day trading?

No. Options trading is buying and selling options contracts, which can happen over days, weeks, or months. Day trading is buying and selling any security (stock or option) and closing the position the same day. You can day trade options, but you don't have to. Day trading has different rules and tax treatment than longer-term trading.