What Are Options

An option is a contract between two people about a possible future trade in a stock. Strip away the jargon and there are only four moving parts.

The four ingredients

• The underlying — the stock the contract is about. One contract almost always covers 100 shares.
• The strike — the fixed price at which the shares may change hands.
• The expiration — the date the contract ends.
• The premium — what the buyer pays the seller for the contract, quoted per share (so a premium of 2.00 costs 200 dollars for one 100-share contract).

Two types, two sides

There are only two types of option. A call is the right to buy the shares at the strike; a put is the right to sell them at the strike. See Calls vs Puts for the full breakdown.

And there are two sides to every contract. The buyer pays the premium and holds the right. The seller (or “writer”) collects the premium and takes on the matching obligation: if the buyer exercises, the seller must deliver. The buyer chooses; the seller is along for the ride, paid up front for the trouble.

What happens at expiration

At expiration an option is either in-the-money (worth exercising) or out-of-the-money (worthless). An in-the-money option is exercised, and the seller is assigned — the shares change hands at the strike. An out-of-the-money option simply expires. In practice, most contracts never get that far: traders close them early by buying or selling them back. More on that in why be the seller.

One detail worth knowing: options on individual U.S. stocks are American-style, meaning they can be assigned any time before expiration, not only on the last day. Many index options are European-style and settle in cash at expiry instead.

Once the four ingredients and two sides are clear, every strategy in the library is just a way of combining them.

Educational only — not investment advice. Options involve a substantial risk of loss and are not suitable for every investor.