What Are Options — Calls and Puts — In Plain Words

This page is educational only. It is not financial advice.

What an option is

An option is a financial instrument known as a derivative. It gives the purchaser — called the option holder — the right, but not the obligation, to buy or sell a set quantity of an asset at a fixed price by a set date.

The other side works the opposite way. The seller of an option, also called the writer, takes on the obligation to buy or sell if the purchaser uses that right.

Options are complex financial instruments. This page explains only what the words mean and what the risks are, in FINRA's own framing.

Two gates before options trading

Trading options requires specific approval from the investor's brokerage firm. That approval is FINRA's own gate, stated on its Options page.

Before trading options, read the “Characteristics and Risks of Standardized Options” disclosure document. FINRA directs readers to that document, provided by the brokerage firm, before any options trading.

Calls and puts

Options come in two types: calls and puts.

• Call: A call gives the holder the right to buy the underlying asset at a set price (the strike price) by a designated date (the expiration date). The seller of a call takes on the obligation to sell at that price if the contract is assigned.
• Put: A put gives the holder the right to sell the underlying asset at a set price (the strike price) by a designated date (the expiration date). The seller of a put takes on the obligation to buy at that price if the contract is assigned.

The facts on a contract

• Strike price: The fixed price at which the holder may buy (for a call) or sell (for a put) the underlying asset.
• Expiration date: The set date by which the contract must be used. It is the last day the contract is valid.
• Premium: The price paid by the purchaser of an options contract, or the price received by the seller of an options contract.
• Contract size: A standard-size options contract is equal to 100 shares of the underlying security.

When the right can be used

American-style: Equity options trade American-style. The holder can exercise the contract at any time between the date of purchase and the expiration date.

European-style: Index options generally trade European-style. The contract can be exercised at expiration only. Index options are cash-settled, which means exercising one results in a cash payment instead of the exchange of a security.

Words to know

• Holder: The purchaser of an options contract.
• Writer: The seller of an options contract. To write is to sell an options contract.
• Exercise: To use the right under the contract — to buy the underlying security (for a call) or sell it (for a put) at the specified price, on or before the specified date.
• Assignment: The assignment of a writer obligates the writer to sell (for a call) or purchase (for a put) the underlying security at the specified strike price.
• In-the-money: The market price of the underlying security is above the strike price of a call, or below the strike price of a put.
• Out-of-the-money: The market price of the underlying security is below the strike price of a call, or above the strike price of a put.
• At-the-money: The market price of the underlying security is equal to the strike price of the contract.
• Intrinsic value: The value of an option if it were to expire immediately with the underlying stock at its current price. It is the amount by which an option is in-the-money.
• Time value: The portion of the premium that comes from the amount of time remaining until the contract expires. It is whatever value the option has in addition to its intrinsic value.
• Open interest: The number of outstanding contracts in a particular options market or an options contract.

The risks — read this part carefully

Options are complex, and buying and selling them can be risky. The risks are different for buyers and sellers, and they can be large.

Leverage: Options offer leverage — the ability to magnify the value or purchasing power of the premium paid. FINRA states plainly that leverage “can come with the risk of significant losses.”

Approval is required: Trading options requires specific approval from the investor's brokerage firm. Before trading options, read the “Characteristics and Risks of Standardized Options” disclosure document provided by the firm.

Risk for the purchaser: For the purchaser of an option, the premium paid is the maximum loss.

Risk for the seller: For the seller of an option, the premium received at the time of the sale is the maximum profit. If the seller of a contract is assigned, they may lose money.

The sharpest risk FINRA names: For an uncovered call — a call sold without owning the underlying stock — the maximum loss is theoretically unlimited. That is because writers have the obligation to buy or sell shares at the strike price if assigned, while purchasers have only the right, not the obligation.

No profit is locked in early: Prices change all the time. Any potential profits aren't guaranteed until a closing transaction is completed or the contract reaches expiration.

This page is educational only. It is not financial advice.