Trading options means buying or selling contracts that give you the right—but not the obligation—to buy or sell a stock at a set price by a certain date

When you trade options, you are not buying or selling the stock itself. Instead, you are trading a contract. That contract is a legal agreement between you and another person (or institution) that says one of you has the right to buy or sell 100 shares of a specific stock at a specific price on or before a specific date. You pay a price upfront to own that right, and that price is called the premium.

The person on the other side of your contract—the one who sold it to you—is betting the stock will move one way. You are betting it will move another way. One of you will be right, and one will lose money. Unlike buying a stock, where you own a piece of a company, an options contract expires. When it expires, it is worthless if the stock price did not move the way you predicted.

Options trading happens on exchanges like the Chicago Board Options Exchange (CBOE), the same way stock trading happens on the New York Stock Exchange or Nasdaq. You place an order through a brokerage account, and the exchange matches you with someone willing to take the other side of the bet.

Key Takeaways

  • An options contract gives you the right to buy or sell 100 shares of a stock at a locked-in price, called the strike price, by an expiration date.
  • You pay a premium upfront to own the contract, and that premium is your maximum loss if the stock moves against you.
  • Options expire on a set date and become worthless if the stock price does not move the way you predicted.
  • Call options let you bet a stock price will go up; put options let you bet it will go down.
  • Most options traders close their position before expiration rather than actually buying or selling the underlying stock.

Calls and puts: the two types of options contracts

Every options contract is either a call or a put. A call gives you the right to buy 100 shares at the strike price. A put gives you the right to sell 100 shares at the strike price. If you buy a call, you are betting the stock price will rise above the strike price before expiration. If you buy a put, you are betting the stock price will fall below the strike price.

The person who sold you the call is betting the stock will stay below the strike price (or not rise enough to make your contract valuable). The person who sold you the put is betting the stock will stay above the strike price. When you buy a contract, someone else is selling it. When you sell a contract, someone else is buying it.

The premium you pay depends on how likely the market thinks it is that the stock will move in your favor. If a stock is trading at $50 and you buy a call with a $55 strike price expiring in one month, the premium will be lower than if you buy a call with a $52 strike price expiring in one month—because the $52 call is more likely to be profitable.

How the premium works and what it costs you

The premium is the price you pay to own the contract. It is quoted per share, but one options contract controls 100 shares, so you multiply the quoted price by 100. If a call premium is quoted at $2, you pay $200 to own that contract ($2 × 100 shares). That $200 is your maximum loss on that trade. If the stock does not move the way you predicted, the contract expires worthless and you lose the entire premium.

The premium changes every second the market is open, just like a stock price does. If you bought a call for $200 and the stock moves in your favor, the premium might rise to $300 or $400. You can sell the contract back to the market at that higher price and pocket the difference. You do not have to wait until expiration to make or lose money.

The premium reflects the time left until expiration and how far the stock would have to move for your contract to be profitable. As expiration gets closer, the premium usually shrinks—even if the stock price does not move. This is called time decay, and it works against you if you own the contract and in your favor if you sold it.

Strike price and expiration date: the two numbers that matter

The strike price is the price at which you have the right to buy (for a call) or sell (for a put) the stock. It is locked in when you buy the contract and does not change. If you own a call with a $50 strike price and the stock rises to $60, you have the right to buy 100 shares at $50 each—a $10 profit per share, or $1,000 total, before subtracting the premium you paid.

The expiration date is when the contract dies. Most stock options expire on the third Friday of each month. Some expire weekly. After expiration, the contract is worthless and you cannot exercise it. If you own a call with a $50 strike and the stock is at $49 on expiration day, the contract expires worthless and you lose the premium you paid.

The strike price and expiration date together determine how much the stock has to move and how much time you have for it to move. A call with a $50 strike expiring in one week is riskier and cheaper than a call with a $50 strike expiring in three months—because you have less time for the stock to move in your favor.

What happens when you close a position or let it expire

Most options traders never actually buy or sell the underlying stock. Instead, they close their position before expiration by selling the contract back to the market. If you bought a call for $200 and it is now worth $500, you sell it and pocket the $300 profit. The person who buys it from you becomes the new owner of the contract.

If you hold the contract until expiration and it is profitable, you have two choices. You can let the brokerage automatically exercise it, which means you buy (for a call) or sell (for a put) 100 shares at the strike price. Or you can sell the contract in the final minutes before expiration if there is still time value left. Most brokerages will exercise your contract automatically if it is in-the-money (profitable) at expiration, unless you tell them not to.

If you hold the contract until expiration and it is unprofitable, it expires worthless and you lose the premium you paid. There is nothing to do—the contract straightforward ceases to exist.

Why people trade options instead of buying stock

Options let you control 100 shares of stock for a much smaller upfront cost than buying the stock outright. If a stock costs $50 per share, buying 100 shares costs $5,000. A call option on that stock might cost $200 to $500. This is called leverage—you can make a larger percentage gain (or loss) with less money at risk.

Options also let you profit if a stock price falls. With a regular stock, you make money only if the price goes up. With a put option, you make money if the price goes down. This gives you more ways to position yourself based on what you think will happen.

Some traders use options to reduce the cost of owning a stock they believe in long-term. Others use them to bet on short-term price moves. Some use them to hedge—to protect gains in a stock they already own by buying a put that pays off if the stock falls. The same tool can be used in many different ways depending on your goal.

Common mistakes when trading options

The biggest mistake is not understanding that time decay works against you if you own the contract. Many new traders buy an option, the stock does not move, and the contract loses value even though they were right about the direction. This happens because the premium shrinks as expiration approaches.

Another common mistake is buying options that are too far out-of-the-money—meaning the stock would have to move a very large amount for the contract to be profitable. These are cheap because they are unlikely to work, and most of the time they expire worthless. Beginners are drawn to them because of the low cost, but the low cost reflects low odds.

A third mistake is not having an exit plan. Many traders hold a losing option all the way to expiration hoping it will turn around, then lose the entire premium. It is usually better to cut losses early and redeploy the money to a trade with better odds. Similarly, some traders hold a winning option too long waiting for a bigger move, and time decay eats into their profit.

Frequently Asked Questions

Do I have to actually buy the stock if I own a call option?

No. You have the right to buy it, but you are not required to. Most traders close their position by selling the contract back to the market before expiration. If you hold until expiration and the contract is profitable, your brokerage will usually exercise it automatically—meaning you will buy the stock—unless you tell them not to.

What is the most I can lose if I buy an option?

The most you can lose is the premium you paid for the contract. If you pay $200 for a call and the stock moves against you, the contract expires worthless and you lose $200. You cannot lose more than that amount because you are not borrowing money or owing anything to anyone.

Can I sell an option I don't own?

Yes. This is called selling to open, and it is how you initiate a short position in options. You sell the contract first, collect the premium, and then buy it back later at a lower price to close the position. This is riskier than buying first because your potential loss is theoretically unlimited (though most brokerages require you to have cash or collateral to sell options).

How do I know what strike price and expiration to choose?

It depends on how much you think the stock will move and how much time you think it will take. If you think a $50 stock will hit $55 in one month, you might buy a $53 call expiring in one month. If you think it will take three months, you might buy a $53 call expiring in three months. Closer strike prices and longer expirations cost more but have higher odds of profit.

What happens if the stock gaps past my strike price?

Your contract becomes more valuable. If you own a $50 call and the stock gaps to $60 overnight, your contract is now worth at least $1,000 (the $10 difference × 100 shares), minus what you paid for it. You can sell it at that higher value or exercise it to buy the stock at $50.