Trading options is buying or selling contracts that give you the right — but not the obligation — to buy or sell a stock at a fixed price by a set date

An option is a contract between two people: one who owns it and one who sold it. The owner has the right to buy or sell a specific stock at a specific price (called the strike price) on or before a specific date (called the expiration date). The seller collects money upfront for taking on that obligation. Trading options means you are either buying these contracts hoping they become more valuable, or selling them to collect that upfront payment.

Unlike buying a stock directly, you do not own the company. You own the right to make a transaction at terms you agreed to in advance. That right has a price, and that price changes every day based on what other traders think the stock will do.

Key Takeaways

  • 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.
  • You pay money upfront to buy an option, and that money is gone if the option expires worthless — you can lose your entire investment.
  • The seller of an option collects that upfront payment but takes on the risk that the stock moves against them.
  • Options expire on a specific date, usually a Friday, and become worthless if you do not use them or sell them before that date.
  • Trading options requires a brokerage account that permits options trading, which usually means passing a brief questionnaire about your experience.

Calls and puts: the two types of options

A call option is the right to buy a stock at the strike price. You buy a call if you think the stock price will go up. If the stock rises above the strike price, your call becomes more valuable — you can sell it for more than you paid, or you can exercise it and buy the stock at the lower strike price. If the stock stays flat or falls, your call loses value and may expire worthless.

A put option is the right to sell a stock at the strike price. You buy a put if you think the stock price will go down. If the stock falls below the strike price, your put becomes more valuable — you can sell it for more than you paid, or you can exercise it and sell the stock at the higher strike price. If the stock stays flat or rises, your put loses value and may expire worthless.

When you sell an option (called writing an option), you are on the other side of the trade. You collect the upfront payment but you take on the obligation. If someone exercises a call you sold, you must sell them the stock at the strike price. If someone exercises a put you sold, you must buy the stock from them at the strike price.

How the price of an option changes

An option's price depends on several things: how far the stock price is from the strike price, how much time is left until expiration, how volatile the stock is, and what interest rates are. The closer the stock price is to the strike price, the more valuable the option usually is. The more time left, the more valuable the option usually is, because there is more time for the stock to move in your favor.

As expiration approaches, an option loses value quickly if the stock has not moved the way you bet. On the expiration date itself, an option is worth either the difference between the stock price and strike price, or zero — there is no middle ground. If you own a call and the stock is below the strike price at expiration, the option expires worthless and you lose your entire investment. If you own a put and the stock is above the strike price at expiration, the same thing happens.

What happens when an option expires

Options expire on a set date, usually the third Friday of each month. On that date, the contract ends. If you own an option that is in the money (meaning it has value), your broker will usually exercise it automatically — you will buy or sell the underlying stock at the strike price. If the option is out of the money (worthless), it simply disappears and you lose whatever you paid for it.

You do not have to hold an option until expiration. Most traders sell their options before expiration day, taking whatever profit or loss exists at that moment. This is how most option trading actually works — buying and selling the contracts themselves, not exercising them to buy or sell stock.

The money you can lose

If you buy an option, the most you can lose is the money you paid for it. If you paid $200 for a call and the stock never moves the way you hoped, that $200 is gone. You cannot lose more than that because you have no obligation — you simply do not exercise the option.

If you sell an option, your losses can be much larger. When you sell a call, you are obligated to sell the stock at the strike price if the buyer exercises. If the stock soars, you lose the difference between what you have to sell it for and what it is actually worth. When you sell a put, you are obligated to buy the stock at the strike price if the buyer exercises. If the stock crashes, you lose the difference between what you have to buy it for and what it is actually worth. These losses can exceed the money you collected upfront.

How to start trading options

You need a brokerage account that permits options trading. Most major brokers (Fidelity, Charles Schwab, E-Trade, Interactive Brokers, Robinhood) offer options trading, but you have to request permission. The broker will ask you questions about your investment experience and financial situation. They are trying to assess whether you understand the risks. Answering honestly is important — if you misrepresent your experience and lose money, the broker is not liable.

Once approved, you can place options trades through your broker's platform the same way you place stock trades. You can buy or sell calls and puts on stocks that have options available (most large and mid-size companies do). You will see the strike prices and expiration dates available, and the current bid and ask prices for each contract. You place an order just as you would for a stock.

Options contracts are standardized: one contract represents the right to buy or sell 100 shares of the stock. If an option is priced at $2, you pay $200 to buy one contract ($2 × 100 shares). If you see a bid-ask spread of $1.95 to $2.05, you can sell at $1.95 or buy at $2.05.

Frequently Asked Questions

Can I lose more money than I put in?

If you only buy options, no — your maximum loss is what you paid. If you sell options, yes — your losses can be much larger than the money you collected. Selling calls on stock you do not own (naked calls) or selling puts can result in losses that exceed your initial premium.

What does it mean when an option is "in the money"?

A call is in the money when the stock price is above the strike price. A put is in the money when the stock price is below the strike price. In the money means the option has intrinsic value — you could exercise it and make money, or sell it for a profit.

Do I have to exercise an option if I own it?

No. You can sell the option contract itself to another trader, or let it expire worthless. Most option traders never exercise — they buy and sell the contracts for profit or loss, then move on to the next trade.

How long do options last?

Most stock options expire on the third Friday of each month. Some brokers offer weekly options that expire every Friday. You can buy options with expiration dates ranging from days away to months away, depending on what the market offers.

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 United States are American-style, which gives you more flexibility.