What Is an Option? One Call and One Put, Followed to Expiry

An option is a contract. It gives its buyer the right to buy or to sell 100 shares at a fixed price, up to a fixed date. The buyer pays for that right up front. The seller takes the money and takes on the matching obligation.

This post is about listed options traded on an exchange. It is not about the options a company grants its own staff as part of their pay, which are a different thing under a similar name. Every worked figure below comes from one hypothetical company, Example Co, trading at $100.

A call is the right to buy 100 shares at the strike. A put is the right to sell 100 shares at the strike. The price paid for that right is the premium, quoted per share. One standard contract covers 100 shares, so a premium quoted at $5.00 a share costs $500.

The premium is paid up front and is not refundable. Whatever happens next, that money has gone.

Taking up the right is called exercising the option. Listed US equity options are American-style, which means the buyer can exercise on any business day up to expiry.

Standard monthly contracts expire on the third Friday of the month. Weekly contracts also trade. Friday is the most common expiry day for single stocks.

Holding to expiry is not the only exit. A position can be closed by selling the contract on, in the same way shares are sold.

Example Co trades at $100. We buy one call at the $100 strike for $5.00 a share, which costs $500. We buy one put at the same strike for $4.00 a share, which costs $400. Both expire on the same day.

Real premiums are set by the market. These are round numbers chosen to make the arithmetic visible.

At expiry one thing decides the outcome: where the share price sits against the strike. A call is then worth the share price minus $100, or nothing. A put is worth $100 minus the share price, or nothing. Subtract the premium already paid and you have the result.

Source: YX Insights

Two rows are worth finding. The call row at $105 is exactly zero. The put row at $96 is exactly zero. Those are the break-evens: the strike plus the premium for a call, the strike minus the premium for a put.

Every row at or below $100 costs the call buyer the same $500, which is the most this call can lose. Every row at or above $100 costs the put buyer $400, which is the most this put can lose.

The table assumes both contracts are held to expiry with nothing else changing. It is before commissions, exchange fees and tax.

Look at the $103 row. Example Co has risen 3%. The call buyer has lost $200.

Nothing has gone wrong. The call is worth $3.00 a share at expiry, so $300, against the $5.00 a share paid for it. A bought call has to clear the break-even, not the strike, before it makes money.

Set that against owning the shares. Buying 100 shares at $100 costs $10,000. At $95 the share owner is down $500, which is 5% of what was put in. The call buyer is down the same $500, which is all of it.

The same arithmetic runs the other way. At $120 the share owner is up $2,000, or 20%. The call is up $1,500 on a $500 outlay, which is 300% of what was paid.

A bought call has no ceiling. A share price can keep rising, so the gain has no fixed limit. The loss stops at the premium.

A put works the other way round. It gains as the share price falls. Its gain is capped, because a share price stops at zero.

At $80 the put is worth $20 a share, so $2,000 for the contract, against the $400 paid. If Example Co fell to zero the put would be worth $9,600 after the premium. That is the most this put can make.

At $100 and above the put expires worthless and the whole $400 is gone.

Every contract has a seller. The seller receives the premium up front, which is the most they can make.

What they can lose is not symmetrical. Selling the $100 call for $5.00 brings in $500. If the seller does not own the shares, a share price has no upper limit, so that loss has no limit either.

Selling the $100 put for $4.00 brings in $400. That loss is bounded, because the share price stops at zero. The bound is $9,600, or 24 times the premium received.

A seller who is called on to deliver has been assigned. With an American-style option that can happen on any business day before expiry. The risk is not confined to the final day.

Time works against the buyer, other things being equal. Part of an option's price is time value, the amount above what it would be worth if it expired today. That part falls as expiry approaches. Time passing helps the seller for the same reason.

An option is in the money when exercising it would be worth something: a call with the share price above the strike, a put with the share price below it.

An option that finishes in the money is usually exercised for the holder. The clearing house exercises contracts that are in the money by as little as one cent a share unless it is told otherwise.

For a call that means paying for 100 shares at the strike, so a buyer without that money risks being exercised into a position they cannot pay for.

Brokers can set a different threshold and an earlier cut-off. The exchanges' final deadline for exercise instructions is 5:30 p.m. Eastern on the expiry day.

The UK tax authority (HMRC) publishes guidance for the managers of a stocks and shares Individual Savings Account (ISA), an account that shelters investments from UK tax. That guidance lists futures and share options among the investments an ISA may not hold.

For Capital Gains Tax, HMRC treats an option as a chargeable asset. A bought option that expires worthless gives a capital loss equal to its premium. A call that is exercised adds its cost to the cost of the shares. How any particular person is taxed depends on their circumstances, including whether their dealing amounts to a trade.

An option is a contract with a price on it. For the buyer, that price is the whole risk. For the seller, it is the whole reward.

This explainer is part of the YX Insights Academy. Each one takes a single idea and checks it against real data.

The same approach runs through everything else we publish:

Good places to start on the website:

A contract that gives its buyer the right to buy or sell 100 shares at a fixed price, up to a fixed date. A call is the right to buy. A put is the right to sell. The buyer pays a premium up front, which is the most they can lose. The seller receives that premium and must buy or sell at that price if the buyer exercises.

Multiply the quoted premium by 100. A call quoted at $5.00 a share costs $500 for one standard contract, because a contract covers 100 shares. The money is paid up front and is not refundable.

Not as a buyer. The premium is the whole loss if the option expires worthless. A seller is different. An uncovered sold call has no limit on its loss, because a share price has no upper limit. A sold put is bounded by the share price reaching zero, which on a $100 strike sold at $4.00 is a loss of $9,600.

It is usually exercised for the holder. The clearing house exercises contracts in the money by as little as one cent a share unless it is instructed otherwise, though brokers can set a different threshold. A call then means paying for 100 shares at the strike. A put means selling 100 shares at the strike, which the holder must own or buy.

DISCLAIMER: This article is strictly educational. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.