What is an option?
An option is a contract tied to an underlying security, such as a stock or an ETF. The contract gives its owner specific rights (or obligations, for the seller) that apply at a defined price through a defined date.
The buyer of an option receives a right. The seller of an option accepts an obligation. The buyer pays a price for that right; the seller receives that price.
One standard equity option contract generally represents 100 shares of the underlying security. So one contract on a stock trading at $100 controls 100 shares.
Calls and puts
There are two basic types of options:
Call
Gives the buyer the right to buy the underlying at the strike price through expiration.
Put
Gives the buyer the right to sell the underlying at the strike price through expiration.
Key terms
Strike price
The price at which the option can be exercised. For a call, it is the price you can buy at. For a put, it is the price you can sell at.
Expiration
The date the contract ends. After expiration, the option no longer exists.
Premium
The price paid for the option. The buyer pays it; the seller receives it.
What can happen
- Options can expire worthless. If the underlying price never reaches a level where the option has value at expiration, the buyer loses the premium paid.
- Contracts can sometimes be exercised or assigned before expiration. Short option positions can be assigned early, particularly if they are in the money.
A simple example
A put with a $90 strike gives its owner the right to sell the underlying shares for $90 through expiration, subject to the contract’s terms.
If you own 100 shares and buy one $90 put, you have the right to sell those 100 shares at $90 through the expiration date. No matter how low the stock falls, you can still sell at $90 - for the 100 shares covered by the contract.
Important: The strike price is not a guaranteed portfolio value. Option cost, share quantity, exercise mechanics, and other positions you hold all affect the actual outcome. The protection applies to the covered quantity and only through the expiration date.