What is an option?
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An option is a contract that gives its holder the right, and not the obligation, to buy or to sell 100 shares of a stock at a fixed price until a fixed date.
Key points
- An option is a contract between a buyer, who holds a right, and a seller, who takes on an obligation.
- A listed option names four things, which are the underlying stock, the strike price, the expiration date and the type, a call or a put.
- The buyer pays the seller a premium, quoted per share. One standard contract covers 100 shares.
- The buyer can lose the whole premium and no more. The seller can lose far more than the premium received.
On this page
Options trade on exchanges, as shares do, and the price of an option follows the price of the stock it is written on. An option is a different thing from a share all the same: it is a contract with an end date, and its two sides hold opposite positions.
The holder decides whether to use the right. This is what separates an option from a purchase of shares: the holder of an option may walk away, and then loses the price paid for the option and nothing more. The writer has no such choice. When the holder uses the right, the writer must do what the contract says.
The four terms of an option contract
Every listed option is described by four terms.
| Term | What it says | Example |
|---|---|---|
| Underlying | The stock the option is written on | XYZ |
| Type | A call, the right to buy, or a put, the right to sell | Call |
| Strike price | The price per share at which the shares are bought or sold | $50 |
| Expiration date | The last day of the option | 15 January 2027 |
The four terms together name one option. "The XYZ January 50 call" is the right to buy 100 shares of XYZ at $50 per share until the January expiration. Calls and puts explains the two types, and Strike price, expiration date and premium the other terms.
What an option costs: the premium
The price of an option is its premium. It is quoted per share, and one standard contract covers 100 shares, so one contract costs the quoted premium times 100.
The premium is paid when the option is bought, and it is not returned. It is no down payment on the shares. It is set by trading on the exchange and it changes through the day with the price of the stock, with the time left until expiration and with how much movement the market expects from the stock.
Who stands behind a listed option
Options on US stocks are listed on options exchanges and they are standardized. The exchanges set the strike prices, the expiration dates and the size of the contract, so one XYZ January 50 call is the same as every other. This is what allows an option to be bought and sold during its life.
Every listed option is issued by the Options Clearing Corporation (OCC), which acts as the central counterparty of the market. A holder who exercises an option looks to the clearing system of the OCC for the shares or the money, and not to the person who wrote the option.
What the holder of an option does not have
An option is not a share. The holder of an option has no vote in the company and receives no dividend. An option also has an end: after its expiration date it does not exist any more. Shares can be held for as long as the company exists. An option that is not worth exercising at its expiration is worth nothing.
What can go wrong with an option
The holder of an option can lose the whole premium. An option that is out of the money at its expiration expires worthless, and the holder has then lost 100% of the money paid for it, even when the stock moved only a little.
The writer of an option holds the opposite position. The premium received is the most the writer can make, and the possible loss is far larger. The writer of a call who does not own the shares faces a loss with no upper limit, because the price of a stock has none. The main risks of options takes them one by one.
These risks are described in full in the Options Disclosure Document, the booklet "Characteristics and Risks of Standardized Options". A person must receive a copy before buying or selling an option, and brokers provide it.
Questions and answers
Why would anyone buy or sell an option instead of just buying and owning the shares?
An option does three things that owning shares cannot. It lets a buyer take part in a move of the stock for a fraction of the price of the shares, with a loss that stops at the premium. It lets an owner of shares set a floor under them by buying a put, as insurance against a fall. And it pays its seller a premium, as income on shares that are owned or for agreeing to buy a stock at the strike price. Each use has a cost that shares do not have. A buyer loses the whole premium when the stock moves too little or too late, because an option expires. A seller gives up the gain above the strike price, or takes on a loss far larger than the premium.
Does the holder of an option receive the dividends of the stock?
No. Dividends are paid to the owners of the shares, and the holder of an option has none of the rights of a shareholder. The holder of a call receives a dividend only by exercising the call before the ex-dividend date and owning the shares.
Can an option be sold before it expires?
Yes. A listed option trades on an exchange during its whole life, and its holder can sell it on any trading day at the price the market offers.
Terms used on this page
- Option
- A contract that gives its holder the right, and not the obligation, to buy or to sell a fixed amount of an underlying asset at a fixed price until a fixed date. A standard stock option covers 100 shares.
- Underlying
- The stock, fund or index an option is written on. The value of the option follows the price of its underlying.
- Strike price
- The price per share at which the holder of an option may buy (a call) or sell (a put) the underlying shares. It is fixed for the life of the option.
- Expiration date
- The last day on which an option exists. An option that was not exercised by then is worth nothing afterwards, and its rights and obligations end.
- Premium
- The price of an option, quoted per share. One standard contract covers 100 shares, so a premium of $1.50 is $150 per contract.
- Options Clearing Corporation
- The clearing house of US listed options. It issues every listed option and acts as the central counterparty, so the holder of an option looks to the clearing system, and not to a particular writer, for performance.
- Options Disclosure Document
- The booklet "Characteristics and Risks of Standardized Options", published by the Options Clearing Corporation. A person must receive a copy before buying or selling an option, and brokers provide it.
Sources
- Characteristics and Risks of Standardized Options, The Options Clearing Corporation (read 29 September 2026). The options disclosure document, edition of June 2024.
- What is an Option?, The Options Industry Council (read 29 September 2026).
- Options Basics, The Options Industry Council (read 29 September 2026).
- What are the Benefits & Risks?, The Options Industry Council (read 29 September 2026).
- Covered Call (Buy/Write), The Options Industry Council (read 29 September 2026).
- Cash-Secured Put, The Options Industry Council (read 29 September 2026).
- An Introduction to Options – Investor Bulletin, U.S. Securities and Exchange Commission (read 29 September 2026).