Options

What are Options?

An option is a contract that gives you the right to buy or sell a stock at a predetermined price (the strike price) before a specific date (the expiration date). You pay a premium for this right. If the trade does not work out, the most you can lose is the premium you paid.

The two types

• Call option: gives you the right to BUY 100 shares at the strike price. You buy calls when you think the stock will go up
• Put option: gives you the right to SELL 100 shares at the strike price. You buy puts when you think the stock will go down

Key terms

• Strike price: the price at which you can buy (call) or sell (put) the underlying stock
• Expiration date: the date the option contract expires. After this date, the option is worthless if not exercised
• Premium: the price you pay for the option contract. This is the maximum you can lose as a buyer
• In the money (ITM): a call with a strike below the current stock price, or a put with a strike above it. These have intrinsic value
• Out of the money (OTM): a call with a strike above the current stock price, or a put with a strike below it. These rely entirely on the stock moving in your direction before expiration
• At the money (ATM): strike price equals or is very close to the current stock price

Why options matter to stock traders

• Unusual options activity: large option orders can signal that someone with information is betting on a move. Traders watch for unusual call or put volume as a potential catalyst
• Options expiration (OpEx): on monthly options expiration (third Friday), stocks with heavy open interest at certain strike prices tend to gravitate toward those strikes. This is called "max pain" or "pinning"
• Gamma squeeze: when market makers who sold call options have to buy the underlying stock to hedge as the price rises, creating a feedback loop that accelerates the move. GameStop in January 2021 was a famous example
• Implied volatility: options prices reflect how much the market expects a stock to move. High IV before earnings means a big move is expected

Options vs stocks for beginners

Options offer leverage (control 100 shares for a fraction of the cost) but they also decay in value every day (time decay or theta). Most beginners should learn to trade stocks profitably before adding options. Options add complexity that can amplify both gains and losses.

You do not need to trade options to be a successful trader, but understanding how options flow affects stock prices will make you a better stock trader.