How Call and Put Options work

A call gives its buyer the right to buy an underlying asset at a specified price, while a put gives its buyer the right to sell. The seller of the option takes on the corresponding obligation.

Options can look complicated because a single contract combines direction, time, price and an obligation between two counterparties. Yet the basic mechanics become much clearer once you separate four positions: a long call, a short call, a long put and a short put.

This guide explains what each position means, how the premium and contract multiplier affect your exposure, how moneyness and time value work and what can happen as expiry approaches. The examples use a hypothetical share trading at USD 100 and, unless stated otherwise, a standard US equity option representing 100 shares.

An option is a financial contract that gives its buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified period. The seller, or writer, takes on the corresponding obligation if the option is exercised and the position is assigned.

Five elements are essential:

1. Underlying: the share, ETF, index, crypto or other asset to which the option refers.
2. Type: a call or a put.
3. Strike price: the predetermined price at which the underlying can be bought or sold.
4. Expiry date: the date on which the option ceases to exist.
5. Contract multiplier: the quantity represented by one contract.

For standard US equity options, one contract generally represents 100 shares, although corporate actions can result in adjusted contracts with a different deliverable.

This multiplier matters. If an option premium is quoted at USD 2.50 per share, one standard contract is worth USD 250:

USD 2.50 × 100 = USD 250

The same principle applies to the obligation behind a short option. A put with a USD 95 strike can potentially require the seller to buy 100 shares for USD 9'500.

A call gives its buyer the right to buy the underlying at the strike price.

Suppose a share trades at USD 100. You buy one call with:

• a strike price of USD 105,
• 60 days until expiry, and
• a premium of USD 2.50 per share.

The contract costs USD 250 before fees.

If the share is at USD 103 at expiry, exercising the right to buy it for USD 105 would not be economically attractive. The option would expire out of the money, and the buyer would lose the USD 250 premium paid.

If the share is at USD 112 at expiry, the call has USD 7 of intrinsic value per share:

USD 112 − USD 105 = USD 7

For 100 shares, that is USD 700. After subtracting the USD 250 premium, the profit at expiry would be USD 450 before fees.

The break-even price at expiry is USD 107.50:

USD 105 strike + USD 2.50 premium = USD 107.50

For a long call, the maximum loss is generally limited to the premium paid, while the potential profit rises as the underlying price increases.

A put gives its buyer the right to sell the underlying at the strike price.

Using the same USD 100 share, suppose you buy a put with:

• a strike price of USD 95,
• 60 days until expiry, and
• a premium of USD 2.20 per share.

The contract costs USD 220 before fees.

If the share falls to USD 88 at expiry, the right to sell at USD 95 has USD 7 of intrinsic value per share, or USD 700 for the contract. Subtracting the USD 220 premium leaves a profit of USD 480 before fees.

The break-even price at expiry is:

USD 95 − USD 2.20 = USD 92.80

A long put is sometimes compared with insurance because it can protect against, or benefit from, a fall in the underlying price. The analogy is useful, but not exact: an option is a traded financial instrument whose value can change before expiry.

Unlike a long call, a long put does not have unlimited profit potential because the price of a share cannot fall below zero.

The distinction between buyer and seller is fundamental.

The option buyer pays the premium and acquires a right. The option seller receives the premium and takes on an obligation for as long as the short position remains open and has not otherwise been closed or expired.

A short call may require the seller to deliver the underlying at the strike price if assigned. A short put may require the seller to buy the underlying at the strike price.

This creates an important asymmetry:

• a long option generally has a maximum loss equal to the premium paid, plus applicable costs;
• a short option generally has a maximum profit limited to the premium received, while its potential loss can be substantially larger.

An uncovered short call has theoretically unlimited loss potential because there is no theoretical ceiling on the underlying share price. A short put has a large but finite maximum loss because the underlying cannot fall below zero.

American-style equity options can also be exercised before expiry. This means a short position can be assigned early. Early exercise may become more relevant for deep in-the-money calls around an ex-dividend date, particularly when little time value remains.

Long means you bought the contract and hold the right. Short means you sold it and carry the obligation.

The words describe your position in the contract and say nothing about your view on the share, which is a common source of confusion. A short put is a bullish position: you want the share to stay above your strike so that the option lapses and you keep the premium.

Moneyness describes the relationship between an option's strike price and the current price of the underlying.

With a share trading at USD 100:

• a USD 95 call is in-the-money (ITM) because its strike is below the share price;
• a USD 105 put is in the money because its strike is above the share price;
• an option with a strike close to USD 100 may be described as at-the-money (ATM);
• a call with a strike above USD 100, or a put with a strike below USD 100, is out-of-the-money (OTM).

Moneyness helps explain an option's intrinsic value.

For a call:

Intrinsic value = max(underlying price − strike price, 0)

For a put:

Intrinsic value = max(strike price − underlying price, 0)

If a USD 95 call is trading at USD 6.40 while the share is at USD 100, it has USD 5 of intrinsic value. The remaining USD 1.40 reflects extrinsic value, often called time value.

An out-of-the-money option has no intrinsic value. Its premium therefore consists entirely of extrinsic value.

An option can be worth more than its intrinsic value because time remains for the underlying price to move before expiry. This additional amount is commonly called time value, or more broadly extrinsic value.

At expiry, time value is zero. Only intrinsic value remains.

Time decay is not constant. All else being equal, the erosion of time value tends to accelerate as expiry approaches, although the actual price of an option is also influenced by movements in the underlying, implied volatility, interest rates, dividends, and other factors.

Implied volatility is particularly important. It reflects the level of future volatility implied by current option prices. Higher implied volatility will generally increase option premiums, all else being equal.

This helps explain why an option can lose value even when the underlying moves in the direction you expected: the move may be too small, arrive too late, or coincide with a fall in implied volatility.

At expiry, an option's remaining economic value is its intrinsic value. An out-of-the-money option has no intrinsic value and generally expires worthless. An in-the-money option may be exercised automatically under the relevant clearing and broker procedures.

For standard US equity options, monthly contracts generally expire on the third Friday of the expiry month, while many actively traded underlyings also have weekly or other expiry cycles.

Three points deserve particular attention.

Before entering an options trade, make sure you can answer these questions:

1. Am I buying or selling the option?
2. What right or obligation does this create?
3. What is the strike price and expiry date?
4. What does one contract represent?
5. What is my maximum potential loss in cash terms?
6. What is my break-even level at expiry?
7. Can the option be exercised before expiry?
8. Is settlement physical or cash based?
9. What happens if I hold the position through expiry?

The most important step is to translate the quoted premium into the actual contract exposure. Options are leveraged instruments, and the premium alone does not describe the size of the obligation behind a short position.

Can you lose more than the premium you paid?

As the buyer of a standard call or put, your loss is generally limited to the premium paid, plus fees and other applicable costs.

As an option seller, the risk is different. A short put can create a substantial obligation to buy the underlying at the strike price, while an uncovered short call can have theoretically unlimited loss potential.

What does out of the money mean in practice?

It means the option has no intrinsic value at that moment. If the option were to expire at the same underlying price, it would expire worthless.

Before expiry, however, an out-of-the-money option can still have value because time remains for the underlying to move.

Do you have to hold an option until expiry?

No. Listed options can generally be closed before expiry by entering an offsetting transaction: selling an option you previously bought, or buying back an option you previously sold.

Are all options based on 100 shares?

No. Standard US equity options generally represent 100 shares, but adjusted contracts and other option products can use different multipliers or settlement structures. Always check the contract specifications.

What happens if you do nothing on expiry day?

It depends on whether the option is in or out of the money, the product's exercise and settlement rules, and your broker's procedures. An out-of-the-money option will generally expire worthless. An in-the-money option may be exercised automatically, potentially creating a share position or cash settlement.

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