What Is an Option? Calls & Puts Explained

Summary

An option is a contract that gives you the right — but not the obligation — to buy or sell 100 shares at a set price by a set date.

The core definition

An option is a standardised contract, listed on a regulated exchange such as the Cboe, that gives its buyer the right — but not the obligation — to buy (a call) or sell (a put) 100 shares of an underlying stock at a fixed strike price, on or before a specified expiration date. The buyer pays a one-time premium up front for that right. The seller (the writer) collects the premium and takes on the corresponding obligation.

Because one contract controls 100 shares, a call option quoted at $2.50 actually costs $250 to buy. That single number embeds four separate ideas: the direction you expect (up for calls, down for puts), how far you expect the move to go (the strike), how much time you're giving it (the expiration), and how much volatility the market currently prices in.

Why options exist

Options were originally created as a hedging tool. A pension fund that owned $50 million of an index could buy put options as portfolio insurance — capping downside for a known premium the same way you cap car-accident cost with an insurance policy. Individual traders now use them for the same three reasons: hedging existing positions, generating income by selling premium against shares they own (covered calls), or making a defined-risk directional bet without tying up the full cost of the shares.

A simple worked example

Imagine Apple trades at $180 and you buy one 30-day $185 call for $3.00 ($300 total). Three things can happen. If Apple closes above $188 on expiration, you're profitable — the intrinsic value of the call exceeds what you paid. If it closes between $185 and $188 you're partially in-the-money but net negative. If it closes at or below $185, the call expires worthless and you lose the full $300 — but nothing more. That capped, known-in-advance loss is the defining feature that makes options different from margin or leverage.

Sri Lankan student note

US-listed options are the deepest, most liquid derivatives market in the world, but they are geo-restricted for many Sri Lankan brokerage accounts. TradeHQ's simulator lets you practice the exact same contracts — Apple, Tesla, SPY — with $100,000 virtual capital, so you can build the mental model long before you ever face a real premium payment.

> Options are contracts, not shares. You are trading a right that decays with time.

(Educational simulation only — not financial advice. Practice everything below with $100,000 virtual cash on TradeHQ.)

Key takeaways

• One option contract = 100 shares of the underlying.
• Calls profit if the stock rises above strike + premium; puts profit if it falls below strike − premium.
• The maximum a long option buyer can lose is the premium paid — nothing more.
• Options were originally invented for hedging, not speculation.

Check your understanding

• How many shares does one standard US equity option contract control? Options: 10; 50; 100; 1,000. Correct answer: 100. Why: US-listed equity options are standardised at 100 shares per contract.
• What is the maximum loss for someone who buys (goes long) a single call option? Options: Unlimited; The strike price × 100; The premium paid; The stock price × 100. Correct answer: The premium paid. Why: A long option buyer can only lose the premium paid.
• A call option gives the buyer the right to: Options: Sell shares at the strike price; Buy shares at the strike price; Short the stock; Receive dividends. Correct answer: Buy shares at the strike price. Why: Call = right to buy. Put = right to sell.
• Why were listed options originally created? Options: Speculation; Tax shelters; Hedging existing positions; High-frequency trading. Correct answer: Hedging existing positions. Why: Options were invented as a hedging tool, similar to insurance.

Sources

• SEC — Investor Bulletin: Options (https://www.sec.gov/investor/alerts/ib_options.pdf)
• Cboe Options Institute (https://www.cboe.com/education/)

Practise this lesson

Open the practice desk and apply this lesson immediately with $100,000 in virtual cash. Concepts become usable when they are rehearsed under simulated conditions, not when they are read. Educational simulation only — not financial advice.