Options & Derivatives
Options 101: Calls, Puts, and the Right to Trade
Options give you the right (but not the obligation) to buy or sell an asset at a fixed price before a specified date. Understanding them unlocks powerful tools for income, speculation, and risk management.
Key rules
- Calls give the right to buy; puts give the right to sell — buying options means you are never obligated to exercise
- Maximum loss for an option buyer is the premium paid — defined risk is the key advantage over shorting
- Options expire worthless if the strike price is not reached by expiration — time decay works against buyers
- ITM options have intrinsic value; OTM options are pure time value — OTM options expire worthless more often
- Never sell options naked (without a hedge) until you fully understand assignment risk and margin requirements
An option is a contract that gives the buyer the right — but not the obligation — to buy (call) or sell (put) an underlying asset at a specified price (strike price) on or before a specified date (expiration date). The seller (writer) of the option has the obligation to fulfil the contract if the buyer exercises it.
**Call Options** A call gives you the right to buy the underlying at the strike price. You buy a call when you expect the underlying to rise. If Apple is at $175 and you buy a $180 call with 30 days to expiration, you profit if Apple rises above $180 + the premium you paid before expiration.
Maximum loss for the buyer: the premium paid. Maximum gain: theoretically unlimited (as the underlying can rise indefinitely).
**Put Options** A put gives you the right to sell the underlying at the strike price. You buy a put when you expect the underlying to fall. If you buy a $170 Apple put and Apple falls to $150, your put has intrinsic value of $20 per share.
Maximum loss for the buyer: premium paid. Maximum gain: strike price minus zero (if the underlying goes to zero).
**Intrinsic Value and Time Value** An option's price (premium) has two components: - **Intrinsic value**: How much the option is already "in the money" (ITM). A $180 call on a $185 stock has $5 of intrinsic value. - **Time value (extrinsic value)**: The additional premium reflecting time remaining and volatility. An OTM option is 100% time value.
**In the Money, At the Money, Out of the Money** - ITM Call: strike below current price - ATM: strike approximately equal to current price - OTM Call: strike above current price (pure time value)
**The Greeks Preview** Option prices are influenced by five key variables: price of the underlying (Delta), time decay (Theta), volatility changes (Vega), and interest rates (Rho). See the Greeks article for detail.