Options basics: calls, puts and why they are riskier than they look

What an option is

A stock option is a contract giving the buyer the right, but not the obligation, to buy or sell 100 shares of a stock at a set price (the strike) before a set date (the expiry). The buyer pays a price for that right, called the premium.

Calls and puts

• Call option: the right to buy at the strike. It gains value generally when the stock rises.
• Put option: the right to sell at the strike. It gains value generally when the stock falls.

Why options are risky

• Expiry: if the stock does not move the right way by the date, the option can expire worthless and the premium is lost.
• Leverage: small price moves can mean large percentage swings in the option’s value.
• Time decay: options lose value as expiry approaches, all else equal.
• Selling options: sellers collect the premium but may be obliged to deliver or buy shares, with losses that can be much larger than the premium received.

Common uses

Professionals use options to hedge existing holdings or to generate income. Some funds sell options systematically for income, which is one reason their payout can be high and their upside capped.

If you cannot explain exactly how you could lose money on an options position, you are not ready to open it. Brokers require approval levels for a reason.