What are Options?

Options are financial contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a specified date. They offer flexibility, leverage, and multiple ways to profit from changing market conditions.

Investors use options for hedging against risk, generating income, or speculating on stock movements. Instead of buying 100 shares of a stock, an investor could buy an option contract for a fraction of the price and still profit from upward or downward movements.

There are two primary types of options: Calls and Puts. A Call option gives you the right to buy the asset, while a Put option gives you the right to sell it. Each option contract typically controls 100 shares of stock.

Options can be complex, and understanding terms like strike price, expiration date, premium, and implied volatility is crucial. While options can greatly enhance returns, they also carry the risk of total loss, making education and careful strategy essential.

In this course, we will cover the basics of options, from how they work to simple strategies for beginners. By the end, you’ll have a strong foundation for building more advanced trading knowledge.

Calls vs. Puts

Options come in two varieties: Calls and Puts. Understanding the difference is fundamental to trading options successfully.

A Call option gives the holder the right to buy the underlying asset at a specified strike price before expiration. Investors buy Calls when they expect the stock price to rise. Sellers of Calls hope the price stays the same or falls, so they can keep the premium received.

A Put option gives the holder the right to sell the underlying asset at a strike price. Buyers of Puts profit when the stock price drops. Sellers of Puts (who take on the obligation) hope the stock price remains above the strike price.

Both Calls and Puts can be bought or sold (also called “written”). Buying options has limited risk (the premium paid), while selling options can carry significant or even unlimited risk if not managed properly.

Knowing when to buy or sell Calls and Puts is the first strategic decision every options trader must make. Understanding market direction and risk tolerance is key to making the right choice.

How Option Pricing Works

Option prices are determined by multiple factors. The main components are:

• Intrinsic Value: The built-in value if the option were exercised now.
• Time Value: The extra amount investors are willing to pay for the possibility of future profits.
• Volatility: Higher volatility increases the likelihood of price swings, raising option premiums.
• Interest Rates and Dividends: Small effects, but important for some traders.

A Call option has intrinsic value when the stock price is above the strike price. A Put has intrinsic value when the stock price is below the strike price.

The longer the time to expiration, the greater the time value. Options lose value as they approach expiration—a phenomenon called time decay.

Option pricing models like Black-Scholes use these factors to calculate theoretical values. However, real-world prices also reflect supply, demand, and trader sentiment.

Understanding why an option is priced a certain way helps traders avoid overpaying and select the best trades for their strategy.