An option is a contract that gives its buyer a right, but not an obligation, to buy or sell an underlying asset at a fixed price (the strike) on or before a set date (the expiry). The buyer pays a premium for that right. The seller collects the premium and takes on the obligation.
Calls and puts
- A call gives the right to buy at the strike. Buyers profit if the price rises well above the strike.
- A put gives the right to sell at the strike. Buyers profit if the price falls well below the strike.
US equity and index options normally cover 100 shares per contract, so a premium quoted as $3.00 costs $300.
| Position | You want price to | Maximum loss | Maximum profit | Breakeven at expiry |
|---|---|---|---|---|
| Buy a call | Rise | The premium paid | Unlimited | Strike + premium |
| Buy a put | Fall | The premium paid | Strike − premium (to zero) | Strike − premium |
| Sell a call | Stay below the strike | Unlimited | The premium received | Strike + premium |
| Sell a put | Stay above the strike | Strike − premium (to zero) | The premium received | Strike − premium |
Worked example
A stock trades at $100. You buy one 100-strike call expiring in a month for $3.00, costing $300.
At expiry at $110, the call is worth $10: $1,000 − $300 = $700 profit. At $103 you break even. At $100 or below it expires worthless and you lose the $300.
American and European exercise
American-style options (most US single-stock and ETF options) can be exercised any time before expiry. European-style options (such as SPX index options) can only be exercised at expiry. Most traders close positions before expiry rather than exercising.
Key takeaways
- An option is the right, not the obligation, to buy (call) or sell (put) at the strike before expiry.
- Buyers pay a premium and risk only that premium; sellers collect it and take on the obligation.
- US equity and index options usually cover 100 shares per contract.
- Breakeven at expiry is the strike plus the premium for calls, and minus it for puts.