Options Contract
What is Options Contract?
An options contract gives the holder the right, but not the obligation, to buy or sell an asset at a set price before a deadline.
A call option is the right to buy; a put option is the right to sell. Options are used to hedge or speculate with limited downside (you can let the option expire). The price paid for the option is the premium.
Options Contract: a worked example
You buy one call on Vantor Corp with a $50 strike expiring in three months, paying a premium of $3 a share on a 100-share contract, so $300 total. Break-even is the strike plus the premium, $50 plus $3, or $53 a share. If Vantor reaches $61, exercising buys 100 shares at $50 and sells at $61, a gross gain of $1,100, less the $300 premium, so $800 net. If Vantor ends at $48, you let it expire and lose the $300 and nothing more. The capped loss beside the uncapped gain is what the premium bought.
The mistake students make with options contract
Students carry the limited-downside idea across to the other side of the trade, but only the buyer's loss is capped. Whoever wrote that call collected $300 and must deliver 100 shares at $50 however high the stock goes; at $90 that costs $4,000 against a $300 premium. The second error is reading limited risk as safe. Options expire, so a call that is right about direction but two weeks late pays nothing at all. Losing the entire premium is the ordinary outcome, not the disaster case.
Options Contract questions
What is the difference between a call and a put option?
A call option is the right to buy at the strike price, and a put option is the right to sell at it. A call gains value as the asset rises above the strike, so buyers use calls to bet on a rise or to cap a purchase price they will face later. A put gains value as the asset falls below the strike, which is why an investor holding a stock can buy puts as insurance against a drop.
What does it mean for an option to be in the money?
An option is in the money when exercising it immediately would produce a gain before the premium is counted. A call with a $50 strike is in the money whenever the stock trades above $50; a put with that strike is in the money below it. In the money is not the same as profitable, because the premium still has to be earned back: at $51 that call is in the money and the buyer who paid $3 is still down $2 a share.
Why do options have a premium?
An option's premium pays for two things, the value it would have if exercised now and the value of the time left for the price to move. A call with a $50 strike on a $52 stock carries $2 of intrinsic value, and anything paid above that is time value, which decays toward zero as expiry nears. Longer time to expiry and a more volatile underlying both raise the premium, since both raise the odds of a large favorable move.
Related terms
Common comparisons
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