Options 101
Calls, puts, premiums and why options can be either insurance or a casino — depending on how you use them.
An option is a contract giving you the right (but not the obligation) to buy or sell a stock at a specified price by a specified date.
The two basic types
- Call option — The right to buy 100 shares at the "strike" price. You buy calls when you expect the stock to rise.
- Put option — The right to sell 100 shares at the strike. You buy puts as insurance against a decline, or to bet on one.
How they're priced
The price of an option (the "premium") depends on five things: the stock price, the strike, time to expiration, volatility, and interest rates. The most famous formula for this is the Black-Scholes model.
The catch
Options expire. If the stock doesn't move enough in your direction by expiration, your option is worth zero. Most beginners lose their full premium. Options are a tool, not a strategy — treat them with respect.