This text applies to U.S. options and, most specifically, to buying call options.
An “option,” or stock option is a contract that gives the person holding it the right to buy or sell [100 shares of] a certain stock at a certain price, before a certain future date.
Why not just buy 100 shares of a stock?
Buying and holding shares of stock has definite advantages and can be profitable, but it is very different than trading options contracts.
As far as options go, you may be thinking, “I couldn’t buy 100 shares of a stock if I wanted to and I don’t have 100 shares of a stock to sell…” and that’s perfectly understandable.
Most traders buy options because they provide leverage that allows them to invest a small(er) amount of money and yet potentially receive a much larger return, often without ever owning a stock, let alone 100 shares of stock.
The options contract itself has value and is salable.
The options contract is also greatly leveraged because it: a) correlates with (“controls,” or “represents”) 100 shares and, b) secures a fixed price for those shares over a period of time.
Imagine if a $50 stock doubled to $100, but that you had a contract that allowed you to still buy 100 of those shares at $50? The contract would have cost a small fraction of what 100 shares would have cost you ($5,000), and would have returned tremendous value.
Why would you want an option?
Because stock prices fluctuate naturally from day to day and over time, having a contract that secures your ability to buy or sell a stock at a certain price, despite those later fluctuations, could prove to be very valuable.
From this, we can also see that simplistically speaking, an investor would do well to take out (buy) an options contract on stocks that are likely to move significantly upward or downward.
(Strategies also exist that could allow an investor to profit off of options taken out on stocks that maintain a tighter range, but these are not the subject of this website.)
As the contract becomes more valuable, you can sell it back to the market, or you can “exercise” the contract (i.e., buy or sell the 100 shares it represents).
Very, very few options trades ever “exercise” a contract—they simply buy the option, hold it for varying amounts of time, then sell it back into the market.
The Parts of an Option
| Part or Aspect | Meaning |
| Strike Date | Date the option contract expires or ends. |
| Strike Price | Price at which you can buy or sell the underlying stock. |
| Premium | The price paid per share to own the option. |
| Underlying (or underlying asset) | The stock the contract applies to. |
Types of Options
There are two types of options, both of which have many and often very complex potential uses.
1. A call option
If after doing “due diligence” and “stacking evidence”—two concepts we’ll cover more on later—you believed that a stock’s price was going to go up, you could take out a call option in order to profit from that increase. This call option would give you the right to buy the stock cheaper despite its subsequent price increase.
In short, a call option is a bet that the stock will rise.
2. A put option
If you believe that a stock’s price was going to go down, you could take out a put option in order to profit from that decrease. This put option would give you the right to sell the stock at a higher price despite its subsequent price decrease.
In short, a put option is a bet that the stock will fall or decrease in value.
Remember this: You can better remember these confusing designations by knowing that Call + Buy go together and that Put + Sell go together (alphabetically and in trading).For purposes of simplicity, this website focuses exclusively on buying call options.
