Puts and calls are the two types of options contracts. A call gives you the right to buy a stock at a set price, while a put gives you the right to sell a stock at a set price. In both cases, you pay a fee upfront called a premium for that right, and the contract expires on a specific date. If the trade doesn’t work out in your favor, you can walk away and lose only the premium you paid.
How a Call Option Works
A call option gives the buyer the right, but not the obligation, to purchase a stock at a fixed price (called the strike price) on or before the contract’s expiration date. You’d buy a call when you believe the stock’s price is going to rise.
Say a stock is trading at $100 and you buy a call with a $105 strike price for a $3 premium. Each options contract covers 100 shares, so the contract costs you $300. If the stock climbs to $120 before expiration, you can exercise your right to buy 100 shares at $105 each, even though they’re worth $120 on the open market. That $15 per share gain, minus the $3 premium you paid, leaves you with $12 per share in profit, or $1,200 total.
If the stock never reaches $105 before expiration, the call expires worthless. You lose the $300 premium and nothing more. That capped downside is one reason options appeal to traders: you know your maximum loss before you enter the trade.
How a Put Option Works
A put option is the mirror image. It gives the buyer the right to sell a stock at the strike price on or before expiration. You’d buy a put when you expect the stock’s price to fall.
Suppose a stock trades at $100 and you buy a put with a $95 strike price for a $2 premium, costing you $200 total. If the stock drops to $80, you can exercise your right to sell 100 shares at $95 each, pocketing a $15 per share difference. Subtract the $2 premium, and your profit is $13 per share, or $1,300. If the stock stays above $95, the put expires worthless and you lose only the $200 premium.
The Key Parts of Every Options Contract
Three components define any option:
- Strike price: The fixed price at which you can buy (for a call) or sell (for a put) the underlying stock. This number stays locked in for the life of the contract.
- Premium: The price you pay to buy the option. It’s determined by factors like how far the stock price is from the strike price, how much time remains until expiration, and how volatile the stock is. The more likely the option is to become profitable, the higher the premium.
- Expiration date: The deadline for using the contract. After this date, the option ceases to exist. Options can expire in days, weeks, or months depending on which contract you choose.
You’ll also hear the term “moneyness.” An option that would be profitable if exercised right now is called in the money. A call is in the money when the stock price sits above the strike price; a put is in the money when the stock price sits below the strike price. An option where the strike price is worse than the current stock price is out of the money and has no intrinsic value, though it still carries time value because the stock could move before expiration.
Calculating Your Breakeven Point
The breakeven price is where you neither make nor lose money on the trade, after accounting for the premium you paid. The formulas are straightforward:
- Call breakeven: Strike price + premium paid
- Put breakeven: Strike price − premium paid
Using the call example above, the breakeven is $105 + $3 = $108. The stock needs to reach $108 for you to start turning a profit. For the put example, it’s $95 − $2 = $93. Below $93, you’re making money. Between the strike price and the breakeven price, you’re recovering some of the premium but not all of it.
Buyers vs. Sellers
Every option has two sides. The buyer pays the premium and receives the right. The seller (sometimes called the writer) collects the premium and takes on an obligation. If you sell a call, you’re promising to sell the stock at the strike price if the buyer exercises the contract, even if the stock has risen far above that level. If you sell a put, you’re promising to buy the stock at the strike price if the buyer exercises, even if it has plummeted.
This means the risk profiles are very different. Buyers can only lose the premium they paid. Sellers, on the other hand, face much larger potential losses. A call seller’s loss is theoretically unlimited because there’s no ceiling on how high a stock can climb. A put seller could be forced to buy a stock that has fallen dramatically below the strike price. In exchange for taking on that risk, sellers keep the premium as income.
What Happens When an Option Is Exercised
Most options traders never exercise their contracts. They close positions by selling the option itself before expiration, capturing or cutting losses on the premium. But if you do exercise, the Options Clearing Corporation (OCC) randomly assigns the obligation to a seller who holds the matching short position.
For a call, the assigned seller must deliver 100 shares at the strike price. If they don’t already own the shares, they have to buy them on the open market first. For a put, the assigned seller must purchase 100 shares from the buyer at the strike price. As long as a short options position remains open, the seller can be assigned on any day the equity markets are open. Your brokerage firm sets its own cut-off times for exercise notices, so it’s worth checking those details before trading.
Why Investors Use Puts and Calls
Options serve three main purposes: speculation, hedging, and income generation.
Speculation is the most straightforward use. Buying calls lets you bet on a stock rising without putting up the full cost of purchasing shares. Buying puts lets you profit from a decline without short-selling the stock. In both cases, options give you leveraged exposure, meaning a relatively small amount of money controls a much larger position.
Hedging works like insurance. If you own 100 shares of a stock and worry about a short-term drop, buying a put establishes a downside floor. You lock in the right to sell at the strike price no matter how far the stock falls. The premium you pay is the cost of that protection, similar to an insurance premium.
Income generation usually involves selling options. A covered call strategy, where you sell a call against shares you already own, brings in premium income. The trade-off is that you cap your upside: if the stock surges past the strike price, your shares get called away. This approach tends to work well in flat or mildly rising markets, where the premium you collect adds to modest price gains.
Risks Worth Understanding
Time works against option buyers. Every day that passes erodes an option’s time value, a process called time decay. An out-of-the-money option can lose value even if the stock moves in your direction, simply because expiration is approaching. This is why many options expire worthless.
Selling options flips that dynamic. Time decay benefits sellers because the option they sold becomes less valuable as expiration nears. But sellers carry the risk of sudden, large moves against them. Selling puts on a stock that collapses or selling uncovered calls on a stock that spikes can generate losses many times larger than the premium collected.
Options also require approval from your brokerage. Most firms assign you a “level” based on your experience and financial situation, and higher-risk strategies like selling uncovered calls require higher approval levels. If you’re new to options, you’ll typically start with permission to buy calls and puts, which limits your maximum loss to the premium paid.