If you’re new to options trading, the terminology and mechanics can seem overwhelming. This guide breaks down the fundamentals in plain English so you can start your options journey with confidence.
What Are Options?
Options are contracts that give you the right, but not the obligation, to buy or sell a stock at a specific price before a certain date.
Think of it like this: An option is similar to a coupon that lets you purchase something at a locked-in price, even if the market price changes.
The Two Types of Options
Call Options
A call option gives you the right to buy a stock at a set price (the “strike price”).
When to buy calls:
- You think the stock price will go UP
- You want leveraged exposure to upside movement
- You want to control shares without buying them outright
Example:
- Apple (AAPL) trading at $180
- You buy a $185 call expiring in 30 days
- If AAPL rises to $195, your call gains value
- If AAPL stays below $185, the call expires worthless
Put Options
A put option gives you the right to sell a stock at a set price.
When to buy puts:
- You think the stock price will go DOWN
- You want to protect existing stock holdings
- You want to profit from downside moves
Example:
- Tesla (TSLA) trading at $250
- You buy a $245 put expiring in 30 days
- If TSLA drops to $230, your put gains value
- If TSLA stays above $245, the put expires worthless
Key Options Terminology
Strike Price
The price at which you can buy (call) or sell (put) the stock. You choose this when buying the option.
Expiration Date
Options have a limited lifespan. They expire on a specific date, after which they become worthless if not exercised.
Premium
The cost of buying an option. This is what you pay upfront and your maximum risk as a buyer.
In-the-Money (ITM)
- Call: Stock price above strike price
- Put: Stock price below strike price
Out-of-the-Money (OTM)
- Call: Stock price below strike price
- Put: Stock price above strike price
At-the-Money (ATM)
Stock price equals (or very close to) strike price.
How Options Pricing Works
Options prices are influenced by several factors:
1. Intrinsic Value
The built-in profit if you exercised right now.
- $200 stock with $190 call = $10 intrinsic value
- $200 stock with $210 call = $0 intrinsic value
2. Time Value
The extra premium based on time until expiration. More time = more value.
3. Volatility
Higher expected volatility = higher option prices. This is why options get expensive before earnings.
4. Stock Price Movement
As the stock moves, option values change:
- Calls gain when stock rises
- Puts gain when stock falls
Buying vs. Selling Options
Buying Options (Long)
- Maximum risk: Premium paid
- Maximum reward: Unlimited (calls) or substantial (puts)
- Best for: Directional moves, lower capital outlay
Selling Options (Short)
- Maximum risk: Substantial to unlimited
- Maximum reward: Premium collected
- Best for: Income generation, range-bound markets
Note: This guide focuses on buying. Selling requires more experience and capital.
Practical Example: Buying a Call
Scenario:
- Microsoft (MSFT) trading at $380
- You’re bullish for the next month
- Instead of buying 100 shares for $38,000…
You could:
- Buy 1 call contract: $385 strike, 30 days out
- Cost: $400 (the premium)
- Breakeven: $389 ($385 strike + $4 premium)
Outcome 1 - Stock rises to $400:
- Your call is worth ~$15 per share = $1,500
- Profit: $1,100 (175% return)
Outcome 2 - Stock stays at $380:
- Your call expires worthless
- Loss: $400 (100% of premium)
Risk Management for Beginners
Start Small
Only risk what you can afford to lose completely. Options can expire worthless.
Understand Time Decay
Every day that passes, your option loses value (all else equal). This accelerates near expiration.
Don’t Hold to Expiration
Take profits at 50-100% gain. Cut losses at 30-50% loss.
Paper Trade First
Most brokers offer practice accounts. Learn without risking real money.
Common Beginner Mistakes
1. Buying Too Far Out-of-the-Money
Cheap options are cheap for a reason. They rarely become profitable.
2. Not Planning Your Exit
Know your profit target and stop loss BEFORE entering the trade.
3. Ignoring Implied Volatility
Buying expensive options before earnings often leads to “volatility crush” losses even if you’re right on direction.
4. Overleveraging
Just because you CAN buy 10 contracts doesn’t mean you should. Start with 1-2.
Next Steps
Now that you understand the basics:
- Open a brokerage account with options approval
- Paper trade for at least 2-3 weeks
- Study the Greeks (delta, theta, vega, gamma)
- Learn basic strategies (covered calls, cash-secured puts)
- Start small with real money
Options are powerful tools that can enhance your trading and investing. Take time to learn, practice discipline, and never risk more than you can afford to lose.
Ready to find your first trade? Check out our Options Screener to discover high-probability setups.