What Is an Options Contract? How Calls and Puts Actually Work
You can be right about the direction and still lose most of your money, because you didn't only buy a view on the price. You bought a deadline.
By Pavel Penev, MScFounder, TradeWize · 10+ years trading the marketsThe short answer
An options contract gives its buyer the right — but not the obligation — to buy or sell an asset at a fixed price, on or before a fixed date. The right to buy is called a call. The right to sell is called a put. The buyer pays a fee upfront, called the premium, and that fee is the most they can lose. The seller collects the fee and takes on the obligation to honour the deal if the buyer chooses to use it. One standard contract normally covers 100 shares, so the quoted price is multiplied by 100 to get what you actually pay.
Two people, same conviction, same Tuesday morning. Both of them have decided that a certain $100 stock is heading higher. She buys the shares. He buys a call option instead — the right to buy that stock at $108 any time in the next 45 days — and it costs him $160. Four weeks later the stock is at $103. It went up, exactly as they both said it would.
She is up 3%. He is down 40%. His option, bought for $160, is now worth $97, and there are 17 days left on it. He was right about the direction and it did not help him even slightly. That gap is the whole subject of this article, and it is not a trick or a fee or a broker taking a cut — it is the instrument working exactly as designed. He didn't only buy a view on the price. He bought a deadline.
What an option actually is
Start away from the markets entirely. You find a second-hand car you like, priced at $6,000. You're not sure yet — you want a few weeks to think, and you're worried the price will go up while you do. So you hand the dealer $200 to hold that price for a month. If the car turns out to be worth $7,000, you come back, pay the agreed $6,000, and you're ahead. If you change your mind, or the car turns out to be a lemon, you simply don't come back. You lose the $200. Nobody chases you for the rest.
That is a call option. Not a metaphor for one — structurally, that is the thing itself. You paid a fee for the right to buy at a fixed price for a fixed period, and the fee was the whole of your risk. Options on shares work the same way, with the same four moving parts, in a market where those rights can be bought and sold all day long.
The word doing the heavy lifting is right. You may buy. You are never required to. This is what separates options from a futures contract, where both sides are locked in and someone has to transact whatever happens. Futures have their own piece in this series, and it's the natural companion to this one.
One consequence of that word is worth flagging early, because everything later in the piece depends on it. The buyer can walk away, so the buyer's loss is capped at the fee. The seller cannot walk away, so the seller's loss is not capped at anything much. Every option is a lopsided deal between those two people, and deciding which of them you want to be is the biggest choice you make with this instrument.
The four things written on every option
Every options contract, on every exchange, comes down to four pieces of information. Learn these four and the rest of the vocabulary is just decoration.
- The underlying — what the contract is about. A share, an index, a commodity, a currency. In our running example it's a stock trading at $100.
- The strike — the fixed price you'd be buying or selling at, if you use the option. Ours is $108. It doesn't move, ever; it's stamped on the contract.
- The expiry — the last day the right exists. Ours has 45 days on it. After that the contract is gone, and nothing about it is negotiable.
- The premium — what you pay for all of the above, quoted per share. Ours is $1.60. This is money out of your account today, and it does not come back.
The same four fields appear on every option ticket you will ever see, in this order. The number most people miss is the last one: the price is quoted per share, and one contract covers 100 of them.
That last line deserves its own paragraph, because it is the single most common shock a new options trader gets, and it takes ten seconds to prevent. Options are quoted per share, but they're sold in contracts of 100 shares. So the number on the screen is not the number on your statement.
The price says $1.60. The till says $160.
Multiply by 100. Always. A contract quoted at $4.20 costs $420, and someone who buys ten of them because they look like small change has spent $4,200. This is not a hidden fee or a trap — it's printed in every contract specification — but it catches people at a rate that suggests nobody reads them.
| The jargon | What it means in plain English | In our example |
|---|---|---|
| Strike | The fixed price you'd buy or sell at if you use the option | $108 |
| Premium | The fee you pay upfront to own the right. Quoted per share | $1.60 a share, so $160 a contract |
| Expiry | The last day the right exists. After it, the contract is gone | 45 days away |
| Call | The right to BUY at the strike. You want the price to rise | What our trader bought |
| Put | The right to SELL at the strike. You want the price to fall — or you own the shares and want protection | The mirror image, covered below |
Five words carry most of the vocabulary. Nearly everything else you'll read about options is a description of one thing: how the fee in row two behaves as the calendar in row three runs down.
Buying a call, all the way through
Our trader pays $160 and gets one thing in return: the right to buy 100 shares at $108, at any point in the next 45 days. The stock is at $100 today, so that right is worth nothing at all right now — why would anyone pay $108 for something they can have for $100? A strike sitting out of reach like that is called out of the money; if the stock climbs past $108 so the right to buy is worth something, that same option is in the money. Ours starts out of it. That's the cheapest kind of call to buy, and it's cheap in the way a raffle ticket is cheap. The price is being honest about the odds.
So what has to happen for this to work? First the stock has to climb above $108, or the right to buy at $108 stays worthless. Then it has to climb past $109.60 — the strike plus the $1.60 already spent — before the trade is actually in profit. That's a 9.6% move required just to get back to even, and it has to happen inside 45 days. Not eventually. By a date.
Now walk the last day. Three things can happen, and there is nothing else.
- The stock finishes below $108. The right to buy at $108 is worth nothing, the contract expires, and the $160 is gone. This is the ordinary outcome, not the disaster scenario.
- The stock finishes between $108 and $109.60. The option has some value — you can buy at $108 something worth more than that — but not enough to cover what you paid. You were right and still finished behind.
- The stock finishes above $109.60. Now you're ahead, and from here every dollar the stock adds is worth $100 to you, because you control 100 shares. At $120, the right to buy at $108 is worth $12 a share — $1,200 on a $160 outlay.
That third line is the entire appeal, and it's a real one. A big move pays out enormously relative to what you risked. The first line is the price of admission, and it's also real: a great many cheap, far-out-of-the-money calls end there. The instrument doesn't hide either fact. It just tends to be sold on the third one.
Being wrong, at least, is clean. There is no margin call, no top-up demand, no possibility of owing anyone money. You lose the $160 and the matter is closed. Compared with the leveraged instruments in the rest of this cluster, that cap is genuinely valuable — it's the one thing options give you that futures and CFDs do not.
Buying a put, the mirror image
Start away from the markets again. You own something valuable and you insure it. You pay a premium, and if the thing gets damaged, the insurer makes you whole at an agreed value. If nothing happens, you've spent the premium and you're perfectly happy about it, because the alternative was worse.
That's a put. It gives you the right to sell at a fixed price, which means it gains value when the price falls. Say you own 100 of those $100 shares and you buy the right to sell them at $95 for the next three months. If the stock drops to $80, you can still sell at $95. The shares fell $20 and your loss stopped at $5 a share, plus whatever the put cost you — the premium is part of the bill, not a rebate against it. If the stock never falls, the put expires worthless and the premium is simply gone.
Puts have a second use, which is simply betting on a fall. Buy a put without owning the shares and you profit if the price drops, with your loss capped at the premium. Compare that with short-selling, where a stock that rises just keeps costing you more, and nothing about the position says where that stops. Short-selling asks how much you can afford to be wrong by; a put answers the question upfront and in writing. The mechanics are the call's mechanics with the direction reversed: a strike, a deadline, a fee, and the same requirement that the move be big enough and quick enough to clear both.
The other side of the trade
Someone sold our trader that call and pocketed his $160. It's worth understanding that seat, because it's the same trade viewed from the opposite chair — and the view is very different.
The seller's best case is fixed on day one: they keep the $160 and nothing more, ever. If the stock goes nowhere, they keep it. If the stock falls, they keep it. If the stock quadruples, they still keep only the $160 — and they now have to deliver 100 shares at $108 to someone who can sell them at four times that. The buyer's loss is capped. The seller's gain is capped. Only one of them has a capped loss, and it is not the seller.
You know exactly what you stand to make. You do not know what you stand to lose. Those two facts should never sit in the same position without a very good reason for it.
There is a tamer version, and it's popular enough to have its own name: the covered call. You sell a call on shares you already own, so if the buyer exercises, you hand over shares you actually have rather than buying them at whatever the market now demands. The unlimited loss goes away. What replaces it is a ceiling on your own shares — you've agreed to sell them at the strike, so any rise above it belongs to someone else.
That's a genuine income strategy with genuine trade-offs, and it earns a proper article rather than a paragraph here. What to avoid in the meantime is the uncovered version, where you sell a call on shares you don't own. Capped income, uncapped regret — and no ceiling on the loss, because there's no ceiling on a share price.
The stock is $100 today. Pick a position, drag the strike and the price you pay, and the picture below shows what you end up with on expiry day for every place the stock could finish. One contract covers 100 shares.
Illustrative — this is the picture on expiry day only, so commissions, dividends, early assignment and everything time value does along the way are left out. The two sliders move independently, which a real options market would not allow: this diagram shows what a position pays at a given strike and premium, never what that premium ought to cost. Now do the one comparison the diagram exists for: set Buy a call, note that the losing side is a flat floor you cannot fall through, then tap Sell a call and watch that same line turn over and walk straight off the bottom of the frame. Both traders agreed on the same premium. Only one of them knows the worst case.
Four positions, one shape drawn four ways. Drag the strike and the premium and watch the break-even point slide with them. The two buying positions bend at the strike and flatten into a small fixed loss — that flat section is your premium, and it's the floor. The two selling positions are those same lines turned upside down, which is why the flat part is now the good news and the running-off-the-chart part is not.
Learn it by doing
Reading about it is one thing — it clicks when you do it. Learn it hands-on with free, interactive lessons on TradeWize.
Try the free lesson →Why you can be right and still lose
Here is the part that explains our opening pair, and it's the most important idea in the article. An option's price is two separate things added together.
The first is what the option would be worth if today were the last day — its intrinsic value. A call with a $108 strike on a $115 stock would be worth $7 a share, because you could buy at $108 and sell at $115. That part is simple arithmetic and it can never be negative — if the strike is out of reach, this piece is just zero.
The second is what the market charges you for the days that remain — its time value. Time is worth money here, because time is opportunity. With 45 days left, a lot can happen. With 3 days left, much less can. So the market prices the remaining days and charges you for them upfront. Then it takes them back, one day at a time, whether or not anything happens.
Our $160 call was entirely the second kind. The strike was out of reach, so the first piece was zero. Every cent of that $160 was payment for 45 days of possibility. And then the possibility started running out.
Assumptions on the chart, all held constant except the calendar: a $100 stock, a $108 strike, 30% implied volatility, 45 days at open. The stock rises 3% in both cases. The only difference is how long it took.
Four weeks in, the stock has done what he said it would. It's at $103. But the strike is still $5 away, there are 17 days left instead of 45, and the market will now only pay $0.97 a share for that shrinking window. His $160 is $97. A 3% gain in the stock produced a 40% loss in the option.
Now run the same move with the clock switched off. Same stock, same $103, same everything — but suppose no time had passed at all. That option is worth $2.54 a share. Not $0.97. His $160 would be $254, a 59% gain, on the identical price move. Same direction, same magnitude, opposite outcome. The only variable that changed is one nobody thinks they're trading.
The value of the remaining days, drawn out to expiry. It doesn't drain evenly — the last stretch is the steep bit, because that's where the possibility runs out fastest.
Notice the shape. The bleed is gentle at first and vicious at the end. With months to go, one day off the clock barely registers. In the final fortnight the same day costs real money, and in the last week the value of the remaining days collapses toward zero, because there is almost nothing left to be possible in. Options with weeks to run are not a cheaper version of options with months to run. They are a different trade wearing the same ticket.
The rent you're paying on the calendar has a name. It's called theta. Nobody sends you an invoice for it. It comes out of the price while you sleep, every night, weekends included. Being right about the direction is only half the job — the market also wants to know when, and it does not accept "eventually" as an answer.
The other thing you're buying: expected drama
One more force sets the premium, and it surprises people because it has nothing to do with which way the price goes. Options cost more when the market expects a big move, in either direction. That makes sense once you see it from the seller's chair: selling someone the right to buy a placid utility stock is a low-risk favour, and selling the same right on a company about to publish results that could halve it is not. The seller charges for the difference.
This expectation has a name — implied volatility — and it does something to option prices that catches beginners twice. In the days before a big scheduled event, premiums inflate, because everyone can see the drama coming. Then the event happens, the uncertainty is resolved, and the premiums deflate immediately, whatever the news was. The market will pay handsomely for a rumour and almost nothing for a fact.
Which produces one of the cruellest experiences in options: you buy a call before earnings, the earnings are excellent, the stock jumps, and your option is worth less than you paid. The good news arrived, but you had already paid for the possibility of it, and that possibility is now spent. Traders call the drop an IV crush, and it's why "buy options before earnings" is a much worse idea than it sounds.
What options are actually for
Options have three legitimate jobs, and you've already met two of them. Protection is the put: a floor under shares you'd rather not sell, bought for a fee that most of the time buys you nothing but sleep. Nobody complains about a year they didn't crash the car. Income is the covered call: a premium collected today in exchange for a cap on your own upside — which is a fine trade in a flat market and an annoying one in the rally you were holding those shares for.
Speculation is the third, and it's what most retail options volume actually is — so it's worth being straight about. The honest case for it is the capped loss: a fixed, known, small-ish amount at risk in exchange for a large payoff if a specific thing happens by a specific date. That is a legitimate structure. The dishonest version is the one that only mentions the payoff, forgets the date, and doesn't tell you what proportion of these tickets are torn up.
Options, futures and CFDs
These three get bundled together as "leveraged products" and the distinctions between them are cleaner than the bundling suggests.
| Instrument | What you're holding | Your maximum loss | Does the clock cost you? |
|---|---|---|---|
| Options (bought) | A right you can walk away from | The premium — no more, ever | Yes. Time value drains to zero at expiry |
| Futures | A binding obligation on both sides | Not capped; margin can be called | No decay, but contracts expire and rolling has a cost |
| CFDs | A private contract with your broker | Not capped by the instrument, though retail rules cap it in some regions | Yes. Financing charged nightly on the full position |
The column that matters is the third one. A bought option is the only instrument here where the worst case is fully known on the day you open it — which is exactly why the deadline in the last column exists. You don't get the cap for free.
Each of the other two has its own article in this series, and they cover the counterparty, margin and financing questions properly rather than in a table row. If you're weighing them up, read all three before choosing.
The risks, stated plainly
Options are where a lot of beginners lose money quickly, and the reasons are structural rather than mysterious. A bought option can go to zero on a move that would barely dent a shareholding. It does so on a deadline, so patience — a virtue almost everywhere else in investing — cannot rescue a position here. The leverage is enormous and slightly hidden: $160 controlling 100 shares of a $100 stock is exposure to $10,000 of stock, and the percentage swings on your money are correspondingly violent. Selling options adds a risk of a different kind entirely, where the loss on an uncovered call has no theoretical ceiling.
Which brings us to the statistic everyone repeats.
"90% of options expire worthless" is not true
You will see this line everywhere, usually as an argument for selling options rather than buying them. It doesn't survive contact with the data. The largest single group of option contracts are closed out in the market before expiry — bought and sold on like anything else, by traders taking a profit or cutting a loss rather than waiting for the final day. A minority expire without value. Only a small fraction are actually exercised.
The myth looks like a misreading of that last line. It is true that options are rarely exercised. Somewhere in the retelling, "rarely exercised" became "expired worthless" — two completely different claims about two completely different piles of contracts. Be careful with the versions of this statistic that come with a precise-looking percentage attached, including the ones citing an exchange or a clearing house: the numbers vary wildly between sources and most of them trace back to another blog rather than to any published dataset.
None of which makes buying options a good idea by default. The honest version is duller than the myth and points the same way: a great many bought options do end up worthless, most positions are closed before that verdict arrives, and the deadline is doing the damage in both cases.
Educational, not advice
This article explains how options work; it is not a recommendation to trade them, and nothing here is personal financial advice. Options are complex, leveraged instruments and are not appropriate for everyone. Rules on access, disclosure and permitted strategies vary considerably between countries, and your broker will typically require you to pass an appropriateness assessment before enabling them. If you want to learn the mechanics, do it somewhere the mistakes are free first.
What's the difference between a call and a put?
A call is the right to buy at a fixed price; a put is the right to sell at one. You'd buy a call if you expect the price to rise, and a put if you expect it to fall — or if you own the shares and want a floor under them. Both cost a fee upfront, and both have a deadline.
Can you lose more than you invest with options?
Not if you're only buying them. A buyer's maximum loss is the premium paid, and that cap is the instrument's single best feature. Selling is a different trade: an uncovered call seller's loss is theoretically unlimited, because there is no ceiling on how high a share price can climb before they have to deliver.
Do most options really expire worthless?
No. Most contracts never reach their final day at all — they're traded on beforehand by holders taking a profit or cutting a loss. Of those that do reach it, a minority expire without value and only a small fraction get exercised. The "90%" figure appears to be a mangled version of that last, much smaller number.
What happens if my option expires in the money?
It is normally exercised automatically. A call becomes 100 shares bought at the strike, and a put sells 100 shares at it — which can mean a large unexpected bill, or a share position you didn't plan for. This is one reason most traders close a position in the market before the final day rather than letting it settle.
What does the option premium actually pay for?
Two things at once: a settled part and a hopeful part. The settled part is whatever you'd gain by using the option right now, which for most options is nothing. The hopeful part is the deadline still being some way off. You pay for both, but only the first one survives to expiry.
Can I sell an option before it expires?
Yes, and most people do. Listed options trade on an exchange like anything else, so you can close a position on any day the market is open and take whatever the contract is worth at that moment. You very rarely have to hold one to expiry or go through exercising it.
Why did my option lose money when the stock went up?
Because you bought time as well as direction, and the time ran down faster than the price moved up. If the stock rises slowly while your strike stays out of reach, the value of the remaining days falls faster than the small gain adds. Right about the direction, wrong about the pace — and the pace is priced.
Are options riskier than shares?
Usually yes, position for position. Shares can sit through a bad year and recover; an option has a date on it and simply stops existing. But the comparison isn't clean, because a bought option risks a known amount and a put held against shares you own actually lowers your risk. What matters most is size — options make it very easy to take a bigger bet than you meant to.
Watch the clock take your money before it's your money
Time decay is one of those things that stays abstract until you've held a position through it. TradeWize's options track teaches calls, puts, strikes and expiries hands-on — you place the trades with virtual coins on live-feel charts, so the first option you watch expire worthless costs you nothing but the lesson.