Calls and puts in plain English

What an option is

An option is a contract. The buyer pays a fee up front and gets the right, but not the duty, to buy or sell 100 shares of a stock at a fixed price until a fixed date. The seller keeps the fee and takes on the duty.

A call is the right to buy. A call buyer is betting the stock goes up. A put is the right to sell. A put buyer is betting the stock goes down, or protecting shares already owned.

The terms on every option

Strike. The fixed price in the contract. A $105 call lets the buyer buy at $105, wherever the stock trades.

Expiry. The last day the contract exists. Standard monthly options expire on the third Friday.

Premium. The option's price, quoted per share. One contract is 100 shares, so a $2.00 premium costs $2 x 100 = $200.

In, at and out of the money

These terms compare the strike with the stock price. Say the stock is at $100.

	Call	Put
In the money	$95 strike	$105 strike
At the money	$100 strike	$100 strike
Out of the money	$105 strike	$95 strike

A $95 call on a $100 stock lets you buy at $95 something worth $100, so it has real value today. An out-of-the-money option has none yet. You pay only for the chance of a big enough move.

Buyer and seller

The buyer can lose only the premium, plus fees. The seller collects the premium and must follow through if the buyer exercises, or uses, the option. A call seller may have to sell 100 shares at the strike. A put seller may have to buy 100 shares at the strike. Selling a call on shares you do not own can, in theory, lose without limit.

Example 1: buying a call

Stock at $100. You buy one $105 call expiring in 30 days for $2.00, so $200. Breakeven at expiry is strike plus premium, $107.

Stock at expiry	Call worth	Profit or loss
$100	$0	-$200
$107	$200	$0
$115	$1,000	+$800

The stock must rise 7% to break even. At or below $105, the full $200 is gone.

Example 2: buying a put

Stock at $50. You buy one $45 put expiring in 30 days for $1.50, so $150. Breakeven is strike minus premium, $43.50.

If the stock ends at $40, the put is worth $45 minus $40 = $5 per share, or $500. Profit: $350. If it ends at $47, the put expires worthless. Loss: $150.

Many buyers sell the option before expiry to keep any value left.

Why cheap options usually lose

A far out-of-the-money option can cost $0.15 per share, just $15 a contract. It feels like small risk for a big payoff, but the price is low for a reason.

On the same $100 stock, a $130 call expiring in two weeks needs a climb of more than 30% to be worth anything at expiry. Few stocks move that far that fast, so most of these contracts end at zero.

Time works against the buyer too. Each day without a big move, the option loses value. This is time decay, and it speeds up near expiry. You can be right on direction and still lose, because the move came too small or too late.

Buying ten cheap contracts instead of one does not improve the odds. It risks ten times as much.

Read Characteristics and Risks of Standardized Options from the Options Clearing Corporation before trading options. Buyers can lose 100% of the premium paid.

Try this

In a paper trading account, open the option chain for a large stock you follow. Pick an expiry about 30 days out. Note the premium for a call near today's price and one about 20% above it, and work out each breakeven. Check both daily until expiry and compare the results.