Options Basics

Master the fundamental concepts of options trading

What is an Option?

An option is a contract that gives you the right, but not the obligation, to buy or sell a stock at a specific price (the strike price) before a certain date (expiration).

Think of it like a coupon: you pay a small fee (premium) for the right to buy something at a fixed price later. If the deal isn't good, you don't have to use it.

Key Terms

Strike Price

The predetermined price at which you can buy (call) or sell (put) the stock.

Example: $100 strike call = right to buy at $100

Premium

The cost to buy the option. This is your max loss when going long.

Example: $5 premium = $500 total cost (100 shares)

Breakeven Point

The stock price where you neither make nor lose money.

Call: Strike + Premium | Put: Strike - Premium

Intrinsic Value

Real value if exercised now. Only ITM options have intrinsic value.

Call: Stock - Strike | Put: Strike - Stock

Long Call

Buy a call = right to BUY at strike. Bullish, limited risk.

Max Loss: Premium | Max Gain: Unlimited

Short Call

Sell a call = obligation to SELL at strike. Bearish, unlimited risk.

Max Loss: Unlimited | Max Gain: Premium

Long Put

Buy a put = right to SELL at strike. Bearish, limited risk.

Max Loss: Premium | Max Gain: Strike - Premium

Short Put

Sell a put = obligation to BUY at strike. Bullish, substantial risk.

Max Loss: Strike - Premium | Max Gain: Premium

Call vs Put Options

Call Options

Right to BUY stock at strike price

  • When to use: Stock will go UP
  • Long Call: Limited risk (premium)
  • Short Call: Unlimited risk
  • Breakeven: Strike + Premium

Put Options

Right to SELL stock at strike price

  • When to use: Stock will go DOWN
  • Long Put: Limited risk (premium)
  • Short Put: Substantial risk
  • Breakeven: Strike - Premium

Long vs Short (Buying vs Selling)

Long (Buying)

  • You pay the premium
  • You have the right to exercise
  • Risk is limited to premium paid
  • Profit potential can be large or unlimited

Short (Selling)

  • You collect the premium
  • You have the obligation to fulfill
  • Risk can be substantial or unlimited
  • Max profit is limited to premium collected

Example Scenarios

Long Call

Bullish

Stock XYZ at $100. You buy a $105 call for $5 premium.

Breakeven:$110
Max Loss:$500
Max Gain:Unlimited

Short Call

Bearish/Neutral

Stock ABC at $100. You sell a $105 call for $5 premium.

Breakeven:$110
Max Loss:Unlimited
Max Gain:$500

Long Put

Bearish

Stock DEF at $100. You buy a $95 put for $5 premium.

Breakeven:$90
Max Loss:$500
Max Gain:$9,000

Short Put

Bullish/Neutral

Stock GHI at $100. You sell a $95 put for $5 premium.

Breakeven:$90
Max Loss:$9,000
Max Gain:$500