Trading options is buying and selling contracts that give you the right to buy or sell a stock at a set price by a certain date

An option is a contract between two people: one person sells you the right to buy (or sell) a specific stock at a locked-in price, and you pay them a fee for that right. You are not buying the stock itself — you are buying the choice to buy or sell it later. The stock price may move up or down, but your right to buy or sell stays at the same price you agreed to when you bought the option.

The person who sells you the option is betting the stock will not move in the direction you want. If the stock moves your way, the option becomes more valuable and you can sell it for a profit, or you can use it to actually buy (or sell) the stock at your locked-in price. If the stock moves the wrong way, your option loses value and you can lose the money you paid for it.

Key Takeaways

  • An option contract gives you the right — but not the obligation — to buy or sell a stock at a set price before a set date.
  • A call option lets you buy a stock at a locked-in price; a put option lets you sell a stock at a locked-in price.
  • You pay an upfront fee (called the premium) to buy an option, and that is the most you can lose if the stock moves against you.
  • Options expire on a specific date, and if you do not use or sell the option by then, it becomes worthless.
  • Trading options is riskier than buying stocks because your money can disappear entirely, and you need a brokerage account that permits options trading.

Call options: the right to buy at a set price

A call option gives you the right to buy a stock at a price you lock in today, even if the stock price goes up tomorrow. You pay a fee upfront (the premium) to own this right. If the stock price rises above your locked-in price, your option becomes valuable — you can buy the stock cheap and sell it at the higher market price, or sell the option itself to someone else for a profit.

For example: you buy a call option to purchase Apple stock at $150 per share, and you pay $5 per share for that right. If Apple stock jumps to $160, your option is now worth at least $10 per share (the difference between $160 and $150), so you could sell the option and pocket the $5 gain. If Apple stock stays at $145 or drops, your option loses value because there is no reason to buy at $150 when you can buy cheaper on the open market. Your loss is limited to the $5 you paid upfront.

Put options: the right to sell at a set price

A put option gives you the right to sell a stock at a price you lock in today, even if the stock price falls below that price later. You pay a premium upfront. If the stock price drops below your locked-in price, your option becomes valuable — you can sell the stock at your higher locked-in price, or sell the option itself for a profit.

For example: you buy a put option to sell Microsoft stock at $300 per share, and you pay $8 per share for that right. If Microsoft stock drops to $280, your option is now worth at least $20 per share (the difference between $300 and $280), so you could sell the option and pocket the $12 gain. If Microsoft stock rises to $310 or stays above $300, your option loses value because you would never want to sell at $300 when the market price is higher. Your loss is limited to the $8 you paid upfront.

The expiration date: when your option stops working

Every option has an expiration date — a specific day when the contract ends and you can no longer use it. Most stock options expire on the third Friday of the month, though some expire weekly. After that date, the option is worthless and disappears, whether it was profitable or not.

This is different from owning a stock, which you can hold forever. With an option, time works against you. Even if you are right about the direction the stock will move, if it does not move far enough or fast enough before expiration, your option can still lose money. This is why options are riskier than stocks — you have a important date, and the clock is always ticking.

The premium: what you pay to own an option

The premium is the price you pay upfront to buy an option contract. It is not the price of the stock — it is the fee for the right to buy or sell the stock at your locked-in price. Premiums are quoted per share, but one option contract covers 100 shares, so if a premium is listed as $5, you actually pay $500 to buy that one contract ($5 × 100 shares).

The premium changes every day based on how likely it is that the option will become profitable. If the stock moves toward your prediction, the premium rises and you can sell the option for more than you paid. If the stock moves against you, the premium falls. The premium is also the maximum you can lose if you buy an option — if the stock moves completely against you and the option expires worthless, you lose only what you paid upfront.

How options trading works in practice

To trade options, you need a brokerage account that permits options trading — not all brokerages allow it, and some require you to meet minimum account balances or pass a knowledge test first. Once you have permission, you can place orders to buy or sell options just like you would buy or sell stocks, using your brokerage's trading platform.

You can close out an option in three ways: sell it before expiration (if it has gained value), use it to actually buy or sell the stock (called exercising the option), or let it expire worthless. Most traders sell the option before expiration rather than exercising it, because selling lets you lock in a profit without having to buy or sell 100 shares of the actual stock.

Options trading happens during regular stock market hours (9:30 a.m. to 4 p.m. Eastern time on weekdays), and you can place orders, change orders, or cancel orders anytime the market is open. Your brokerage will show you the current premium for any option you are interested in, and you can see how much profit or loss you have on any option you own.

Why people trade options instead of buying stocks

Options let you control a larger amount of stock with less money upfront. Buying 100 shares of a $150 stock costs $15,000; buying one call option on that stock might cost $500. This means a small move in the stock price can create a large percentage gain on your option money — but it also means a small move against you can wipe out your entire investment.

Options also let you profit if a stock price falls (by buying a put option), whereas buying a stock only makes money if the price rises. Some traders use options to hedge their stock holdings — for example, buying a put option on a stock you own protects you if the price drops, similar to insurance.

The risks of trading options

Options are riskier than stocks in several ways. First, you can lose your entire investment. If you buy a call option for $500 and the stock does not move the way you predicted, that $500 can disappear completely when the option expires. With a stock, you can hold it forever and wait for the price to recover.

Second, time decay works against you. Every day that passes, an option loses value even if the stock price does not move, because there is less time left for the stock to move in your favor. Third, options require you to predict not just the direction the stock will move, but also how far and how fast — getting two out of three right is not enough.

Fourth, options are more complex than stocks, and mistakes are expensive. You can accidentally buy the wrong expiration date, the wrong strike price, or the wrong type of option (call instead of put). You also need to understand how your brokerage handles options at expiration — some automatically exercise options, others let them expire, and the rules vary.

Frequently Asked Questions

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

No. You have the right to buy the stock, but you are not required to. Most traders sell the option before expiration instead of exercising it. If you do nothing and the option expires, it straightforward disappears and you lose the premium you paid.

What is the difference between buying a call and selling a call?

Buying a call means you pay a premium and get the right to buy a stock at a set price — you profit if the stock rises. Selling a call means you receive a premium from someone else and give them the right to buy a stock from you at a set price — you profit if the stock stays flat or falls. Selling options is riskier because your potential loss is much larger than the premium you received.

Can I trade options on any stock?

Most major stocks have options available, but not all. Your brokerage will show you which stocks have options. You also need a brokerage account that permits options trading, and some brokerages require you to pass a test or meet a minimum account balance before you can start.

What happens if I own an option and the stock splits?

The option contract adjusts automatically. If a stock splits 2-for-1, your option to buy 100 shares at $150 becomes an option to buy 200 shares at $75. The total value stays the same, but the number of shares and the strike price both change.

How much money do I need to start trading options?

There is no set minimum, but most brokerages require at least $2,000 in your account to trade options, and some require more. You also need enough cash to pay the premium for the options you want to buy. Selling options has higher requirements because your potential loss is larger.