Options

An option is a contract tied to some underlying asset — usually a stock — that gives its owner the right, but not the obligation, to buy or sell that asset at a set price by a certain date. You can let the contract expire worthless if you don't want to use it; that's the "not the obligation" part. There are two basic types: a call gives the right to buy, and a put gives the right to sell.

Every option has a strike price (the fixed price at which the buy or sell would happen) and an expiration date (the deadline for using that right). The price you pay to own the option is called the premium, and that's the most a buyer can lose. On the other side of the trade is the seller (also called the writer), who collects the premium but takes on the obligation to fulfill the contract if the buyer decides to exercise it — so the seller's risk profile looks very different from the buyer's.

The nuance that trips up beginners is that an option's value depends on more than just whether the stock moved in the right direction. Time remaining until expiration and the market's expectation of future price swings (implied volatility) both feed into the premium, so an option can lose value even while the underlying stock is moving the way you predicted, simply because time is running out or expected volatility dropped. This is why options are described as decaying assets — every day that passes, all else equal, chips away at the extrinsic (time-based) portion of the price.

Options are traded in standardized contracts, and one contract typically controls 100 shares of the underlying stock, so the dollar amounts move faster than the per-share numbers suggest. This built-in multiplier is a form of leverage: a small move in the stock can produce a large percentage move in the option's price, which cuts both ways for buyers and sellers.