Options 101

An option is a contract that gives you the right to buy or sell 100 shares of a stock at a fixed price, until a fixed date. That is the entire idea. Everything else in this track is a consequence of it.

You are not buying the stock. You are buying an agreement about the stock — one with a deadline attached. That deadline is what makes options behave unlike anything you have met so far in this playbook, and it is the source of nearly every way beginners lose money on them.

The six words

What buying a call actually means

Suppose a stock trades at $100 and you buy one $105 call expiring in 14 days for a premium of $1.15. You have paid $115 for the right to buy 100 shares at $105 any time in the next fortnight.

If the stock goes to $112, that right is worth having — you can buy at $105 something worth $112, so the contract is worth at least $7 per share, or $700. You paid $115. If the stock sits at $100 and never moves, nobody wants the right to buy at $105, the contract expires, and your $115 is gone.

In practice almost nobody exercises the right. You sell the contract to someone else at whatever it is now worth, exactly as you would sell a share. The right to buy is what gives the contract value; the contract is the thing you trade.

And buying a put

The mirror image. A $95 put gives you the right to sell 100 shares at $95. If the stock falls to $88, that right is worth $7 per share, because you can sell at $95 something worth $88. If the stock rises, nobody wants the right to sell below the market, and the contract expires worthless.

In, at, and out of the money

Buyer and seller

Every contract has two sides. The buyer pays the premium and gets the right. The seller — the writer — receives the premium and takes on the obligation to deliver if the buyer exercises.

This playbook teaches buying only. Selling options has its own logic and its own risks, and a naked short call carries theoretically unlimited loss in exactly the way a short stock position does. Learn the buy side properly first.

Why you can be right and still lose

This is the part that catches everyone, so meet it now rather than in a losing trade. The stock can move in your direction and your contract can still lose money. Three reasons, and the widget below lets you cause each one deliberately.

• It did not move far enough. An out-of-the-money option needs the stock to travel past the strike before it has any real value — a 2% move on a contract that needed 6% pays nothing.
• It did not move fast enough. Every day that passes takes value out of the contract. That is theta, and it never pauses.
• The market got calmer. If expectations of future movement fall, every contract reprices downward — even the ones pointing the right way. That is the volatility effect, and after an earnings report it is brutal.

What to take from this module

1. One contract is 100 shares

   Multiply every quoted price by 100 before you decide anything about size.

2. Calls for up, puts for down

   Both are bought the same way, and both lose their entire value if you are wrong.

3. Strike and expiration are your two choices

   Direction is the easy part. Those two decisions are where most of the outcome is determined — Module O6 is entirely about making them.

4. Maximum loss is the premium

   Known in advance, and frequently realised in full.

5. Direction is necessary, not sufficient

   You need direction, magnitude and timing. Shares only ask for the first.