Options: A Beginner’s Guide to Key Terms and Concepts

Contracts. Calls. Puts. Premium. Strike price. Intrinsic value. Time value. This is the language of options traders — a jargon-riddled dialect of traditional Wall Street speak. Gaining fluency requires learning a few key terms. Here are the essentials of options trading for beginning investors.

What are options?

Options are contracts that give investors the right to buy or sell a stock or other security at a set price by a certain date. Call options are profitable if the underlying security rises in price, while put options are profitable if it falls.

An options contract isn't an obligation to buy or sell the underlying security. You can also let the contract expire, as the name suggests. However, when buying options, you’ll pay a premium up front, which you’ll lose if you let the contract expire.

» Know the basics and ready to start? See our options trading guide for strategies and tools

Why trade options?

Typically, people trade options for three reasons: hedging, speculation or profit. Deciding whether to buy or sell — or which options trading strategy to use — largely depends on your objectives.

Hedging. Options can act as a “hedge” or as a sort of insurance to potentially help minimize risk from sudden changes in the market. Purchasing a protective put on a stock you own, for example, can help combat any resulting losses from that stock suddenly dropping. Selling covered calls on a stock you own can help you generate income if the stock is trading sideways.

Speculation. Similar to stocks, options can also be used in a speculative manner. You can place a bet on how a stock will perform over time, then purchase an options contract that reflects that view. The benefit is that you don’t have to own the underlying stock to purchase the contract and, if your bet doesn’t pan out, the maximum amount of money you’ll lose is your initial investment.

Profit. Some traders also use options for more general profit earning. That is, options can play a part in their larger investment strategies. Sellers (or "writers") can make a profit from the premiums they charge buyers. But they can also suffer a loss or miss out on gains because of their obligation to fulfill the contract at the strike price.

» Want some practice before getting started? Here are the brokerages that offer free paper trading accounts.

Basic options terms

Option contract: An instrument that lets investors bet on which direction they think a stock price is headed. A contract typically controls 100 shares of the underlying stock.

Call option: A contract that gives you the right to buy a stock at a predetermined price before an expiration date.

Put option: A contract that gives you the right to sell shares at a stated price before an expiration date.

Exercise: An option buyer's right to buy the underlying stock (for calls) or sell it (for puts) at the strike price, on or before the expiration date. A buyer does not have to exercise an option if it would be unprofitable for them to do so.

Expiration date: The date when the options contract becomes void. It’s the due date for you to exercise the contract (or not), and it can be days, weeks, months or years in the future.

Strike price, or exercise price: The price at which you can buy or sell the stock if you choose to exercise the option. (Not to be confused with market price, which is the actual, current price of the stock on the stock exchange.)

Premium: The per-share price you pay for an option. The premium consists of:

• Intrinsic value: The value of an option based on the difference between a stock’s current market price and the option’s strike price.

• Time value: The value of an option based on the amount of time before the contract expires. Time is valuable to investors because an option’s intrinsic value may increase over the contract’s term. As the expiration date approaches, the time value decreases

  This is known as time decay, or "theta," after the options-pricing model used to calculate it.

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American-style contract: An option that can be exercised at any point up to the expiration date. Common for options on stocks and ETFs.

European-style contract: An option that can only be exercised on the expiration date. Common for options on indexes like the S&P 500.

How options are valued

When it comes to describing options performance, saying “up,” “down,” or “flat” doesn’t cut it. At any given moment that an options contract is in play, it is one of three things:

In the money: "In the money" (ITM) refers to an option that has intrinsic value — in other words, one that would be profitable to exercise (without accounting for premiums and transaction fees). An option is ITM when the relationship between the stock price in the open market and the strike price favors the option's contract owner. When the market price of the underlying stock is higher than the strike price, that’s good news for the owner of a call option. A put option is in the money if the stock price is lower than the strike price.

Out of the money: When there's no financial benefit to exercising the option, it's called "out of the money" (OTM). Practically speaking, an out-of-the-money option makes buying or selling shares at the strike price less lucrative than buying or selling on the open market. A call option is OTM if the stock price is lower than the strike price. A put option is OTM when the stock price is higher than the strike price.

At the money: When the stock price is roughly equal to the strike price, an option is considered "at the money" (ATM). Basically, it’s a wash (although in practice, exercising an option at the money usually incurs a slight loss for the holder due to the premium they paid and any transaction fees charged by the broker or government regulators).

Breakeven price: Many options trading platforms calculate the minimum (or maximum) price for the underlying stock of an options contract at which the contract would actually be profitable to exercise. For a put buyer, this is the strike price minus the premium paid and transaction fees, and for a call buyer, it's the strike price plus the premium paid and transaction fees.

Buyers vs. seller terminology

These last couple of terms cover the types of options traders. This is another case where traditional terms like “buyer” and “seller” don’t quite capture the nuances of options trading.

Holder (buyer): A person who owns an options contract. Holders can buy options contracts from writers or from previous holders. A call holder pays to exercise the option to buy the stock under the contract's terms. A put holder has the right to sell the stock. If an option is in the money, a holder can exercise it (buying the underlying stock at the strike price in the case of a call, or selling it at the strike price in the case of a put), or they can resell it to another holder before the expiration date, hopefully for a higher price than they paid for it. If it's out of the money, they can let the option expire worthless, without exercising it. In this case, they lose their premium.

Writer (seller): A person who sells a new options contract. The writer of an option collects a premium from the buyer, and is obligated to sell them the underlying stock at the strike price (for a call option) or buy the underlying stock from them at the strike price (for a put option) on or before the expiration date, if the holder exercises the option. If they don't, the writer gets to keep the premium without doing anything.

Writers generally want their options to be in the money at the time of sale, since this yields a high premium, but out of the money at expiration, since this lets them walk away with the premium and avoid buying or selling the underlying stock at an unprofitable price. But even if an option ends up in the money and does get exercised, writers can sometimes make a small profit. The breakeven price for a put seller is the strike price minus the premium received, minus transaction fees. For a covered call seller, it's the price they paid for the underlying stock, plus the premium received, minus transaction fees.

Covered call: Selling a call option on a stock you own at least 100 shares of.

Cash-secured put: Selling a put option on a stock when you have at least enough free cash to buy 100 shares of the stock at the option's strike price.

Naked option sale: Selling an option without owning enough collateral to meet your obligations (100 shares of the underlying stock for a call, or enough cash to buy 100 shares at the strike price for a put). If you write a naked call and it's exercised, you will be forced to buy 100 shares of the stock at the market price and then immediately sell them at the (lower) strike price. If you write a naked put and it's exercised, your account may be overdrawn to buy 100 shares at the strike price. Naked option sales are extremely risky because they have unlimited loss potential and can push your account balance into the negatives if they go wrong.

» More on buying and selling options: Options trading overview

How to read a stock option quote

When you call up a stock quote, you get the current market share price of the company — the amount you’d pay if you bought shares or the amount you’d receive if you sold them. Quotes for options contracts are much more complex. For starters, you’ll see a table of available option contracts, called an option chain. Each contract represents a different way to trade based on type, expiration date, strike price and more.

Here's a real screenshot from Yahoo Finance of the option chain for the world's most valuable publicly traded company, Nvidia (NVDA). Each row in the table contains key information about the contract. We've defined the terms below, from left to right.

Contract name: Just like stocks have ticker symbols, options contracts have option symbols with letters and numbers that correspond to the details in a contract. This is what the letters and numbers mean, in order from left to right:

1. Underlying stock ticker symbol. In this case, NVDA.

2. Expiration date in YY/MM/DD format. In this case, 260316, meaning March 16, 2026.

3. C for "call" or P for "put."

4. Strike price, written in $00,000.000 format, where the first digit is tens of thousands of dollars and the last is tenths of a cent. In the case of the topmost option above, the strike price is $115, written as 00115000.

Last trade date: The date and time of the last transaction on this contract.

Strike: The price you'd pay or receive if you exercised the option.

Last price: The price that was paid or received the last time the option was traded.

Bid: The price a buyer is willing to pay for the option. If you're selling an option, this is the premium you'd receive for the contract.

Ask: The price a seller is willing to accept for the option. If you want to buy an option, this is the premium you'd pay.

Change: The price change since the previous trading day’s close, also expressed in percentage terms.

Volume: The number of contracts traded that day.

Open interest: The number of options contracts currently in play.

Volatility: A measurement of how much a stock price swings between the high and low price each day. Historic volatility, as the name implies, is calculated using past price data. It can be measured annually or over a specific time frame.

Implied volatility, or “IV” in options-quote shorthand, measures how likely it is that the market thinks a stock will experience a price swing. (You also might hear of "vega," the option pricing model used to measure the theoretical effect that each one-point change in the stock price has on implied volatility.) Higher implied volatility typically leads to higher option prices because of greater potential upside for the contract. But don’t take these calculations as certainties. Just as earnings estimates are merely an analyst’s prediction of what a company is likely to earn, volatility measures are only predictions about how much an option’s price may change.

Advantages and disadvantages of options

Now that we've covered some basic terminology, let's talk about why investors learn all this jargon. Investors use options for different reasons, but the main advantages are:

• Buying an option means taking control of more shares than if you bought the stock outright with the same amount of money.

• Options are a form of leverage, offering magnified returns.

• An option gives an investor time to see how things play out.

• An option protects investors from downside risk by locking in the price without the obligation to buy.

But there are also risks, namely:

• You can lose your entire investment in a relatively short period^[0]

  The Options Clearing Corporation. Characteristics and Risks of Standardized Options. Accessed Mar 26, 2026.

  View all sources

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• It can get a lot more complicated than buying stocks — you have to know what you’re doing.

• With certain types of options trades (particularly those that involve writing options without collateral), it's possible to lose more than your initial investment.

» Is options trading better than stocks? Learn about the differences between stocks and options

Simple options buying examples

Finally, let's put it all together. Even simple options transactions, like buying puts or buying calls, can be difficult to explain without an example. Below, we're walking through a hypothetical call option and put option purchase.

An example of buying a call

Imagine a company called XYZ Corp. with a share price of $100. If you think the price is going to rise to $120 by some future date, you could buy a call option with a strike price less than $120 (ideally, a strike price no higher than $120 minus the cost of the option, so that the option remains profitable at $120).

If the stock does indeed rise above the strike price, your option is in the money. That means you can exercise it for a profit, or sell it to another options trader for a profit. If it doesn't, your option is out of the money, and you can walk away having only lost the premium you paid for the option.

An example of buying a put

Similarly, if you think XYZ's share price is going to dip to $80, you could buy a put option (giving you the right to sell shares) with a strike price above $80 (ideally a strike price no lower than $80 plus the cost of the option, so that the option remains profitable at $80).

If the stock drops below the strike price, your option is in the money, and you can profit from it. Otherwise, you'd forfeit the premium and walk away.