Options basics: calls, puts, strike, expiry and premium
Learn the rights and obligations of option buyers and sellers and calculate the result of simple call and put positions at expiry.
What you will learn
- What calls and puts are and who has rights and who has obligations
- The meaning of strike, expiry, premium, multiplier, exercise and assignment
- The difference between American and European style options and the terms in, at and out of the money
- How to calculate the profit, loss and break-even of a bought call and a bought put at expiry
Explanation
An option is a contract that gives the buyer a right but no obligation. The seller has the obligation to fulfil the contract if the buyer uses the right.
- A call option gives the right to buy the underlying at a fixed price.
- A put option gives the right to sell the underlying at a fixed price.
The key terms:
- Strike price (exercise price): the fixed price at which the underlying can be bought or sold.
- Expiry date: the last day the right exists.
- Premium: the price the buyer pays the seller for the option. It is paid at the start and is not returned.
- Multiplier (contract size): how many units of the underlying one contract covers. For many equity options it is 100 shares, but this varies; always check the exchange specification. Prices are quoted per share, so a premium of €2.00 with a multiplier of 100 costs €200 per contract.
- Exercise: the buyer uses the right. Assignment: the seller is chosen to fulfil the obligation.
- Writer: another word for the option seller, who is "short" the option.
Style and moneyness
An American-style option can be exercised on any trading day until expiry. A European-style option can only be exercised at expiry. The names have nothing to do with geography; many options in Europe are American style and many index options in the US are European style.
Moneyness describes where the underlying price is relative to the strike:
- In the money (ITM): exercising would have value. Call: price above strike. Put: price below strike.
- At the money (ATM): price roughly equal to the strike.
- Out of the money (OTM): exercising would have no value. Call: price below strike. Put: price above strike.
Rights versus obligations: the asymmetry
The buyer of an option can lose at most the premium. The seller receives the premium but takes on an obligation whose cost can be much larger. A seller of a call without owning the underlying (a "naked" call) has, in theory, unlimited risk. Brokers therefore require margin from option sellers and often restrict which strategies retail clients may use.
At expiry the simple results per share are:
- Long call: max(price − strike, 0) − premium. Break-even = strike + premium.
- Long put: max(strike − price, 0) − premium. Break-even = strike − premium.
Worked example
Hypothetical example: a share trades at €50. Multiplier 100 shares. No fees, no taxes, results at expiry.
Bought call: strike €55, premium €2.00. Cost: €2.00 × 100 = €200. Break-even: €55 + €2 = €57.
- Share at €60: value (€60 − €55) × 100 = €500. Profit €500 − €200 = €300.
- Share at €56: value (€56 − €55) × 100 = €100. Result €100 − €200 = −€100 (above the strike, but below break-even).
- Share at €52: the call expires worthless. Loss = premium = −€200.
Compare: buying 100 shares at €50 costs €5,000. At €60 that gives +€1,000 (+20%); the call gives +€300 on €200 (+150%). At €52 the shares gain €200 (+4%), but the call loses 100%. Leverage works in both directions.
Bought put: strike €45, premium €1.50. Cost: €150. Break-even: €45 − €1.50 = €43.50.
- Share at €40: value (€45 − €40) × 100 = €500. Profit €500 − €150 = €350.
- Share at €48: the put expires worthless. Loss = −€150.
The sellers of these two options have the exact opposite results: for example the call seller gains €200 if the share is below €55 at expiry, and loses €300 if it is at €60.
Common mistake
Practice activity
Hypothetical: a share trades at €80. You buy 1 put with strike €75 and premium €3.00, multiplier 100. Ignore fees.
- What does the put cost in total, and what is the break-even price?
- What is your result at expiry if the share is at €70?
- What is your result at expiry if the share is at €76?
- Is the put in, at or out of the money when you buy it?
Show solution
1. Cost €3.00 × 100 = €300. Break-even €75 − €3 = €72.
2. Value (€75 − €70) × 100 = €500. Result €500 − €300 = +€200.
3. €76 is above the strike, so the put expires worthless: −€300.
4. Out of the money: for a put, a share price (€80) above the strike (€75) means exercising would have no value.
Limitations: this looks only at expiry. Before expiry the option price also contains time value (next lesson), so you can sell it for more or less than these values.
Key takeaways
- Calls give the right to buy, puts the right to sell; the seller has the obligation.
- The buyer's maximum loss is the premium; the seller's risk can be much larger.
- Break-even: call = strike + premium; put = strike − premium.
- Always multiply the quoted premium by the contract multiplier to get the real cost.
Next step
In the next lesson you will split an option's price into intrinsic value and time value and learn what implied volatility tells you.
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