Skip to main content

🗓️ 02112025 2330
📎

OPTIONS BASICS

Core Concept: Options are contracts giving the right (not obligation) to buy or sell stock at a specific price before expiration.

Why It Matters​

Options provide leverage and flexibility but introduce time decay and complexity. Understanding the fundamentals prevents costly errors.

When to Use​

✅ Use options when:

  • Want leverage without buying full stock position
  • Need portfolio insurance (protective puts)
  • Generate income on existing holdings (covered calls)
  • Defined risk requirement (max loss known upfront)

❌ Avoid when:

  • Don't understand the risks
  • Can't monitor positions regularly
  • Undercapitalized (need $2k-25k for margin)

Core Components​

Call option: Right to BUY stock at strike price
Put option: Right to SELL stock at strike price

Premium: Price paid for the option contract
Strike price: Agreed transaction price
Expiration date: Last day option is valid
Contract size: 100 shares per contract

Trade-offs​

Pros: Leverage, defined risk, income generation, portfolio hedging
Cons: Time decay, complexity, total loss potential, requires active management

Options pricing builds on intrinsic_extrinsic_value and options_greeks.

Quick Reference​

TermDefinitionExample
ITMIn-the-money (has intrinsic value)$50 call, stock at $55
ATMAt-the-money (strike ≈ stock price)$50 call, stock at $50
OTMOut-of-the-money (only extrinsic value)$50 call, stock at $45
LongBuying option (pay premium)Bullish call, bearish put
ShortSelling option (receive premium)Bearish call, bullish put

Contract notation: TICKER YYMMDD C/P STRIKE
Example: AAPL 250117 C 180 = Apple Jan 17, 2025 $180 Call

P&L formulas:

Long Call Profit = (Stock Price - Strike - Premium) × 100
Long Put Profit = (Strike - Stock Price - Premium) × 100
Max Loss (Long) = Premium Paid × 100

Examples​

EXAMPLE

Long call scenario:

You buy: AAPL 250117 C 180 for $5.00 premium
Cost: $500 ($5 × 100 shares)

At expiration:

  • Stock at $190: Profit = ($190 - $180 - $5) × 100 = $500
  • Stock at $185: Break-even (intrinsic value = premium paid)
  • Stock at $175: Loss = $500 (premium lost, option expires worthless)

Long put scenario:

You buy: AAPL 250117 P 180 for $4.00 premium
Cost: $400

At expiration:

  • Stock at $170: Profit = ($180 - $170 - $4) × 100 = $600
  • Stock at $176: Break-even
  • Stock at $185: Loss = $400 (premium lost)

Covered call scenario:

You own 100 AAPL shares at $180, sell 180 call for $3 premium
Income: $300 collected immediately

Outcomes:

  • Stock stays below $180: Keep shares + $300 premium
  • Stock above $180: Shares called away at $180, keep $300 premium
  • Effective sale price: $183 ($180 strike + $3 premium) ```

References​