Calls and puts

An option is a contract that gives the buyer a right, not an obligation, to buy or sell something at a fixed price before a set date.

• A call is the right to buy. Calls gain when price goes up.
• A put is the right to sell. Puts gain when price goes down.

The four words

• Underlying: what the option is on (a stock, an ETF like QQQ, an index like SPX).
• Strike: the fixed price in the contract.
• Expiry: the date the right runs out.
• Premium: what the buyer pays for the right. It's the price of the option.

US stock and ETF options usually cover 100 shares, so the premium you see is multiplied by 100.

One worked example

Stock XYZ trades at $100. You buy one $105 call that expires in a month, for a premium of $2.00.

• Cost: $2.00 × 100 = $200. That's the most you can lose.
• At expiry, XYZ is at $110: the call is worth $110 − $105 = $5.00, or $500. Your profit is $500 − $200 = $300.
• At expiry, XYZ is at $104 or lower: the right to buy at $105 is worthless. You lose the $200.
• Breakeven: strike + premium = $107.

A put works the same way in reverse. A $95 put gains as XYZ falls below $95.

Quick recap

1. Call = right to buy. Put = right to sell.
2. Strike, expiry, premium. Usually 100 shares per contract.
3. A buyer's maximum loss is the premium paid.