An option gives its holder a contractual right linked to an underlying asset. A call generally gives the right to buy; a put generally gives the right to sell. The strike price, expiration, exercise style and settlement method determine what that right means in practice.

Buying an option is not simply a cheaper way to buy a stock. The contract can lose value even when the underlying moves in the direction you expected.

Read the contract before doing the arithmetic

Standard US equity options commonly represent 100 shares, but adjusted contracts and other products can differ. American-style options generally allow exercise before expiration; European-style options generally allow exercise only at expiration. Some settle through delivery of the underlying, while others settle in cash. FINRA's options overview explains these contract distinctions.

An option quote is normally expressed per underlying unit, rather than as the total contract payment. A quoted premium of $3 with a 100-share multiplier costs $300 before transaction charges. Verify the multiplier instead of applying 100 to every product.

A hypothetical call and put at expiration

Assume an ordinary 100-share contract and ignore fees. You pay $3 per share for a call with a $100 strike. At expiration, if the stock is $105, the call has $5 per share of intrinsic value. That is $500 of value against a $300 premium, giving a $200 net payoff. Its expiration breakeven is $103.

If the stock is $101, the call is in the money but its $100 intrinsic value is less than the $300 paid. Correctly predicting an increase did not produce a profit.

For a put with the same strike and premium, a $95 expiration stock price produces $500 of intrinsic value and a $200 net payoff. Its expiration breakeven is $97. These are expiration calculations, not predictions of the option's resale price beforehand.

Why the premium changes before expiration

Remaining time and implied volatility affect the option's market value alongside the underlying price. A reduction in implied volatility can offset a favorable stock move. Time decay describes a model sensitivity with other inputs held constant, not a promise that every option quote falls by a fixed amount each day.

Bid-ask spreads also matter. A theoretical or last-traded value may not be the price available when closing the position. Assess a prospective trade using executable quotes and the actual contract's liquidity.

Exercise creates a different position

For a standalone purchased option, the premium can be lost in full. However, exercising a physically settled contract can create a stock position and additional financial exposure. Do not treat the original premium as the maximum risk of every resulting position.

In-the-money contracts can be exercised through expiration procedures unless appropriate instructions apply. Broker deadlines can precede exchange deadlines. The Options Industry Council explains exercise mechanics and assignment risk.

The seller has obligations if assigned. An uncovered call can create theoretically unlimited losses; that does not mean every option-selling structure has the same risk. A spread, covered position and uncovered position require separate payoff and operational analysis.

FAQ

Can I sell a purchased option before expiration? Often, if the market is open and a counterparty is available. Execution price and liquidity are not guaranteed.

Must I exercise a profitable option? No. Closing it can be an alternative, subject to liquidity and account permissions.

Is an option approval the same as suitability? No. Broker permission does not establish that the strategy fits your finances or experience. Compare contract types in our market overview.

Key Takeaways

  • Identify multiplier, exercise style and settlement method first.
  • Direction alone does not determine profit.
  • Understand both the option payoff and any exposure created by exercise or assignment.