What is an option? Calls and puts from zero
The two basic option contracts explained with plain numbers: what a call and a put give you, what they cost, and how their payoffs look at expiration.
By PB, options traderPublished 4 min read
An option is a contract about a future transaction. One side pays money now for the right to trade shares at a fixed price later; the other side accepts that money and takes on the matching obligation. Everything else in options trading — every spread, every Greek, every volatility strategy — is built from this one asymmetric agreement.
There are exactly two basic contracts.
A call option gives its buyer the right, but not the obligation, to buy 100 shares at a fixed price on or before a deadline. A put option gives its buyer the right, but not the obligation, to sell 100 shares at a fixed price on or before a deadline. That is the whole taxonomy. Everything traded on an options exchange is calls, puts, or combinations of them.
The four parts of every contract
Look at any option and you will find the same four components:
The underlying is the stock (or ETF, or index) the contract references. The strike price is the fixed price at which the trade may happen. The expiration date is the deadline after which the contract ceases to exist. And the premium is what the buyer pays the seller for the right — quoted per share, so a premium of 3.00 means $300 per contract, because standard US equity options carry a contract multiplier of 100.
A concrete example, using round hypothetical numbers throughout: a stock trades at 200 and grants the right to buy 100 shares at $105 any time until the March expiration.
What the buyer of a call is really betting
Suppose you buy that 105 call for 2.00. Walk the outcomes at expiration:
If the stock finishes at 105 is worthless — nobody pays 103 stock. The option expires, and the loss is the 105 exactly, at 50: below the strike, the loss is the premium, never more.
If the stock finishes at 105 is worth 200 of value exactly offsets the premium paid: $107 is the breakeven, always strike plus premium for a long call.
If the stock finishes at 10 per share, or 200 paid — a 100 of option value.
That shape — flat loss of the premium below the strike, then rising one-for-one above it — is the call’s payoff diagram, and it is worth internalizing visually:
Contract multiplier: 100 (US equity options)
- Net debit
- $300.00
- Max profit
- Unlimited
- Max loss
- −$300.00
- Breakeven
- 103
| Leg | Side | Type | Strike | Premium | Qty |
|---|---|---|---|---|---|
| 1 | long | call | 100 | 3 | 1 |
Notice what the picture makes obvious. The buyer’s risk is defined: the premium, full stop. The reward is open-ended. In exchange for that pleasant asymmetry, the buyer needs the stock not merely to rise, but to rise past the strike plus the premium, before the deadline. Direction alone is not enough — a stock that drifts from 104 by expiration was “right” directionally and still lost this trade 100% of its premium.
The put is the mirror image
A long put profits when the stock falls below the strike by more than the premium paid. Buy the 100-strike put for 3.00 and the breakeven is 100 of profit, down to the (very large but finite) maximum if the stock goes to zero. Above the strike, the put expires worthless and the loss is the $300 premium.
Contract multiplier: 100 (US equity options)
- Net debit
- $300.00
- Max profit
- $9,700.00
- Max loss
- −$300.00
- Breakeven
- 97
| Leg | Side | Type | Strike | Premium | Qty |
|---|---|---|---|---|---|
| 1 | long | put | 100 | 3 | 1 |
Puts have two natural jobs: expressing a bearish view with defined risk, and insuring shares you already own — a use covered properly in the long puts lesson.
Where the premium goes: the seller
Every option bought is an option sold. The seller of that 105 call received 105 if assigned. The seller’s payoff is the buyer’s flipped upside down: keep at most $200, with losses growing dollar-for-dollar as the stock rises past the breakeven.
This is the moment to install a permanent piece of mental furniture: options do not create money; they transfer it, minus costs. Whether the buyer’s defined-risk bet or the seller’s steady premium collection is the better business depends entirely on the price — a question that occupies most of Levels 2 and 3.
Next, the natural question — why does the option cost 2.00 rather than 1.00 or 4.00? — which is where intrinsic and extrinsic value come in.
FAQ
- Do I need a lot of money to trade options?
- No — one contract on a mid-priced stock often costs a few hundred dollars or less. But small accounts are less forgiving of mistakes, so the sizing lesson later in this level matters more, not less.
- Can I lose more than I pay when buying an option?
- Not when buying. A bought call or put can go to zero, and that is the end of it — the premium paid is the maximum loss. Selling options is a different story, covered later in this level.
- What happens if I just hold an option past expiration?
- Nothing sits in your account afterward — the option either expires worthless or, if it is in the money by $0.01 or more, is exercised automatically into a share position. That automatic exercise can surprise people, which is why the expiration lesson exists.