What Is an Option?
An option is a derivative contract that gives its holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price, called the strike price, on or before an expiration date. The buyer pays the seller an upfront fee called the premium for this right.
Because the holder can simply let the option expire if exercising it would be unprofitable, the maximum loss for an option buyer is limited to the premium paid. The seller, by contrast, collects the premium but takes on potentially large obligations.
Calls vs. Puts
A call option gives the right to buy the underlying at the strike price, so it gains value when the asset's price rises. A put option gives the right to sell at the strike, so it gains value when the price falls.
An option's premium has two components: intrinsic value, which is how far the option is already in the money, and time value, which reflects the chance the option becomes more valuable before expiration. Higher volatility and more time to expiry both make options more expensive.
Example
Say a stock trades at $100 and you buy a call option with a $105 strike expiring in three months for a $3 premium. If the stock climbs to $115, your option is worth $10 at expiration, a $7 profit per share on a $3 outlay, roughly a 233% return while the stock rose 15%.
If the stock stays below $105, the option expires worthless and you lose the $3 premium, which is your entire risk.
Why It Matters
Options let investors hedge portfolios, generate income, and make leveraged bets with defined risk, and they underpin much of modern risk management. Options prices also encode the market's expectations of future volatility, which is why traders watch measures like the VIX.
Derivatives and options desks in sales and trading are among the most quantitative roles in markets, and employee stock options make the concept directly relevant to anyone's compensation in tech or startups.
