What Are Options?

In This Lesson

Complete introduction to options contracts and terminology.

Duration: 25 min

Overview

Complete introduction to options contracts and terminology. This lesson will provide you with practical knowledge and actionable insights you can apply to your trading immediately.

By the end of this lesson, you'll have a clear understanding of the concepts and be able to apply them in real trading scenarios. Let's dive into the details.

Key Concepts

Call Options

Contracts giving the right (not obligation) to buy 100 shares at a specific price by expiration.

Put Options

Contracts giving the right to sell 100 shares at a specific price by expiration.

Strike Price

The price at which the option can be exercised. Determines if option is in-the-money or out-of-the-money.

Expiration Date

When the option contract expires. American options can be exercised anytime before expiration.

Premium

The price paid to buy an option, consisting of intrinsic value plus time value.

Practical Application

Now let's put this knowledge into practice. Follow these steps to apply what you've learned:

1. Open options chain on your trading platform for a liquid stock like AAPL or SPY
2. Identify at-the-money calls and puts - strike prices closest to current stock price
3. Compare option prices at different strikes - notice intrinsic vs time value
4. Look at different expiration dates - see how time affects option prices
5. Calculate breakeven points: Call breakeven = Strike + Premium, Put breakeven = Strike - Premium
6. Paper trade a few simple long calls and puts to understand profit/loss mechanics

Common Mistakes to Avoid

Treating Options Like Lottery Tickets

Buying cheap, far out-of-the-money options hoping for massive returns leads to consistent losses.

Ignoring Time Decay

Not understanding that options lose value every day (theta decay) causes unexpected losses even when direction is correct.

Confusion About Assignment

Not understanding when and how options can be exercised early, especially on dividend stocks.

Key Takeaways

Options provide leverage but come with time decay risk
Buying options requires being right on direction AND timing
Most options expire worthless - sellers have statistical advantage
Start with buying calls and puts before attempting complex strategies
Understanding intrinsic vs time value is crucial for option pricing

Your Next Steps

Ready to continue your learning journey? Here's what to do next:

• Review this lesson's key concepts
• Complete the practical exercises
• Take notes on what you've learned
• Practice with a demo account
• Move on to the next lesson when ready