What an Option Is: Calls, Puts and Contracts

EDUCATION, NOT ADVICE · Options can lose all of their value quickly. The example stock. Every price in this course comes from the Black-Scholes model for one example stock: price $100, volatility 25% a year, interest rate 4%, no dividends, 90 days to expiration. Real quotes differ. Full disclosures →

A right, not a duty

An option is a contract between a buyer and a seller. The buyer pays the seller a price, called the premium. A call gives the buyer the right to buy shares at a set price, the strike price. A put gives the buyer the right to sell shares at the strike price. The right ends on the expiration date.

The buyer does not have to use the right. If the option has no value at expiration, the buyer lets it go and loses only the premium.

The seller has the duty

To use the right is to exercise the option. When a call buyer exercises, the seller must sell the shares at the strike price. When a put buyer exercises, the seller must buy the shares at the strike price. The seller learns of this from a notice, called an assignment.

So the two sides are not equal. The buyer has a right and a known cost. The seller has a duty and a known income, which is the premium.

One contract is 100 shares

Option prices are quoted per share. A contract generally represents 100 shares, so one contract costs 100 times the quote. In the table, the 105 call costs $3.31 a share, which is $331 for one contract.

Strike	Call, per share	Put, per share	Call, one contract	Put, one contract
$90	$12.00	$1.12	$1,200	$112
$95	$8.34	$2.41	$834	$241
$100	$5.43	$4.45	$543	$445
$105	$3.31	$7.28	$331	$728
$110	$1.89	$10.81	$189	$1,081

The table is an option chain for our example stock at $100, with 90 days to expiration. Each row is one strike. A call with a lower strike costs more, because the right to buy at a low price is worth more. Puts work the other way.

In the money and out of the money

A call is in the money when the stock is above the strike. A put is in the money when the stock is below the strike. An option is at the money when its strike is near the stock price.

With the stock at $100, the 90 and 95 calls are in the money. The 105 and 110 calls are out of the money. For puts, it is the reverse.

American style and European style

The owner of an American-style option can exercise it at any time before expiration. The owner of a European-style option can exercise it only in a short period just before expiration. The examples in this course use American-style options on a stock.

Long and short

You are long an option when you buy it. You are short an option when you sell one that you did not own first. A short option gives you the premium now and the duty later.

The example stock in this course

Every lesson uses the same stock, so you can compare the results. The stock costs $100. Its volatility is 25% a year, the interest rate is 4%, and it pays no dividend.

Each option has 90 days to expiration, unless the lesson says otherwise. A model script calculates each price with the Black-Scholes model. Real quotes have a bid and an ask, and they differ from these model prices.

Key points

A call is a right to buy. A put is a right to sell.
The buyer pays the premium and gets the right. The seller receives the premium and takes the duty.
One contract generally covers 100 shares, so multiply each quote by 100.

Definitions in the field guide: volatility. Next: the four basic positions.

Sources

SEC, Investor Bulletin: An Introduction to Options, for the definitions of calls, puts and assignment, and the 100-share contract.
OCC, Trading Options: Understanding Assignment, for American and European style, and random assignment.
Fischer Black and Myron Scholes, The Pricing of Options and Corporate Liabilities, Journal of Political Economy, 1973, for the model that gives every price in this course.