What is an options contract?

An options contract is a financial agreement between two parties that gives the buyer the right, but not the obligation, to buy or sell 100 shares of a stock at a predetermined price, before or on a specific date.

The key word is right. Unlike buying stock, you're not committing to the transaction. You're paying for the option to make that transaction if it becomes favorable.

The four key components of any options contract

Every options contract is defined by four things:

1. The underlying asset

The stock or ETF the contract is based on. Common underlyings include AAPL, TSLA, SPY, and QQQ. The contract controls 100 shares of that underlying.

2. The strike price

The fixed price at which you can buy (call) or sell (put) the underlying. You choose this when you enter the trade.

3. The expiration date

The last day the contract is valid. After this date, the option either gets exercised (if it has value) or expires worthless. Standard monthly options expire on the third Friday of each month.

4. The premium

The price you pay to buy the contract. One contract = 100 shares, so multiply the quoted premium by 100 to get your total cost. A $3.00 premium = $300 per contract.

Two types of options contracts

Call options give the buyer the right to buy the underlying at the strike price. You buy calls when you're bullish, expecting the stock to rise.

Put options give the buyer the right to sell the underlying at the strike price. You buy puts when you're bearish, expecting the stock to fall.

Buyers vs sellers

Every options contract has two sides:

A simple example

AAPL is trading at $185. You buy one call contract:

• Strike: $190
• Expiry: 30 days from now
• Premium: $3.00 → you pay $300 total

If AAPL rises to $200 by expiry, your contract is worth at least $10 per share ($1,000). You paid $300, so your profit is $700.

If AAPL stays below $190, your contract expires worthless. You lose your $300 premium, nothing else.

American vs European style

Most US equity options are American style, they can be exercised any time before expiration. Index options (SPX, NDX) are typically European style, they can only be exercised at expiration.

In practice, most traders never exercise options early. They simply sell the contract back in the market to capture its remaining value.

Why trade options instead of stock?

Options offer several advantages over owning shares outright:

• Leverage: Control 100 shares for a fraction of the cost
• Defined risk: Buyers can never lose more than the premium paid
• Flexibility: Profit in up, down, or sideways markets
• Income generation: Selling options generates premium income on existing positions

The tradeoff: options expire. If you're wrong on timing, you can lose your entire premium even if you're eventually right on direction.

Related terms: Call option, put option, strike price, premium, expiration date, underlying asset