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Options Basics for Beginners
Before learning specific strategies like cash-secured puts and covered calls, it helps to understand the basic language and structure of options.
What Is an Option?
An option is a financial contract tied to an underlying asset, such as a stock or ETF. Options have specific terms including a strike price, expiration date, and premium.
Unlike buying shares of stock directly, an options contract represents rights and obligations based on the terms of the contract.
Calls and Puts
There are two main types of options: calls and puts.
Call Option
A call is generally associated with the right to buy shares at a specific strike price before or at expiration.
Put Option
A put is generally associated with the right to sell shares at a specific strike price before or at expiration.
One Contract Usually Represents 100 Shares
For standard U.S. equity options, one contract typically represents 100 shares of the underlying stock or ETF.
Example
If an option premium is quoted at $1.00, one standard contract would generally represent $100 in premium because $1.00 × 100 shares = $100.
Strike Price
The strike price is the price specified in the option contract. It helps determine the price at which shares may be bought or sold if the contract is exercised or assigned.
Premium
The premium is the price of the option contract. Buyers pay premium, while sellers receive premium when the position is opened.
The amount of premium can change throughout the life of the option based on factors such as stock price movement, time remaining, volatility, and the option's strike price.
Expiration Date and DTE
Every option has an expiration date. DTE means "days to expiration" and tells you how much time remains before the contract expires.
As expiration approaches, the behavior and value of an option can change significantly.
Buying vs. Selling Options
Option buyers and option sellers have different objectives, risks, rights, and obligations.
The OptionEdge focuses primarily on understanding the option-selling side of strategies such as cash-secured puts and covered calls.
Assignment
When you sell certain option contracts, assignment can create an obligation to buy or sell shares according to the terms of the contract.
Assignment is not automatically a bad outcome, but it is important to understand the obligation before entering any short option position.
Options Involve Risk
Options are not risk-free. The risks vary depending on the strategy, position size, underlying security, strike price, expiration, and market conditions.
Before trading options, it is important to understand both the potential return and the possible downside of the strategy you are using.
Key Terms to Remember
Underlying
The stock or ETF connected to the option.
Contract
The option agreement being traded.
Strike Price
The price specified by the contract.
Premium
The price paid or received for the option.
Expiration
The date the option contract expires.
DTE
The number of days remaining until expiration.
Assignment
When the option seller must fulfill the contract obligation.
Exercise
When an option buyer uses the rights of the contract.
Video Lesson
What Is an Option? — Options for Beginners
Watch the supporting OptionEdge video for a visual explanation of what options are, how they work, and why investors use them.
Watch on YouTubeReady for the First Strategy?
Once these basics make sense, the next step is learning how a cash-secured put works from start to finish.
Learn Cash-Secured PutsFor educational and informational purposes only. Nothing on The OptionEdge constitutes financial or investment advice.