Option

Stock trading dictionary: meaning, example and how traders use it.

Last updated: October 17, 2026

Definition: An option is a contract that gives its buyer the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a specified strike price on or before a set expiration date, in exchange for a premium paid to the seller.

How options work

Options are derivatives whose value depends on an underlying asset, most often a stock, an ETF, or an index. A standard US equity option covers 100 shares. Every contract has:

  • Type: a call option (right to buy) or a put option (right to sell).
  • Strike price: the price at which the underlying can be bought or sold.
  • Expiration date: after which the contract ceases to exist.
  • Premium: the price the buyer pays the seller (writer), quoted per share.

Listed options trade on exchanges and clear through the Options Clearing Corporation. Most US stock options are American-style and can be exercised any time before expiration; many index options are European-style and can be exercised only at expiration.

Option pricing basics

A premium has two parts. Intrinsic value is how much the option is in the money: for a call, stock price minus strike, if positive. Time value is the rest, reflecting time remaining, interest rates, dividends, and expected volatility. Time value decays as expiration approaches, which works against buyers and in favor of sellers.

Example of an option trade

Suppose a stock trades at $50 and a call with a $55 strike expiring in three months costs $2.00, or $200 per contract.

  • If the stock rises to $62 at expiration, the call is worth $7.00. The buyer's profit is $7.00 - $2.00 = $5.00 per share, or $500, a 250% return on the premium.
  • If the stock ends at $55 or below, the call expires worthless and the buyer loses the full $200.
  • The break-even price at expiration is the strike plus the premium: $57.

The seller of that call collects $200 up front. If the seller owns 100 shares, the position is a covered call; if not, the seller faces potentially unlimited losses as the stock rises.

How investors use options

Hedging: buying puts can limit losses on a stock or portfolio, similar to insurance. Income: selling covered calls or cash-secured puts collects premium in exchange for giving up some upside or committing to buy. Speculation: options provide leverage, so a small move in the stock produces a larger percentage change in the option. Spreads: combining options, such as a credit spread, defines risk and reward.

Options are complex. Buyers can lose 100% of the premium quickly, and uncovered sellers can lose far more. Brokers require approval levels before allowing different strategies.

Frequently asked questions

What is the difference between a call and a put?

A call gives the right to buy the underlying at the strike price, while a put gives the right to sell it at the strike price.

How many shares does one stock option cover?

A standard US listed equity option covers 100 shares of the underlying stock, so the quoted premium is multiplied by 100.

Can you lose more than you invest in options?

Option buyers can lose at most the premium paid, but sellers of uncovered options can face losses much larger than the premium received.

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For information only, not investment advice. See the disclaimer.