This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Options: Getting Started

When it comes to investing, it's nice to keep your options open.

Options allow you to make a bet on the direction of an underlying investment such as a stock, bond or market index without actually buying that investment. In addition to investing in options, Wall Street follows options trading to glean investor sentiment about the market as well as individual stocks. The days that certain options expire can have a volatile impact on the broader market.

There are countless ways investors use options -- from using them as a hedge to avoid a big loss in a stock to making very risky bets that a stock will rise or fall -- but they revolve around two simple choices: options to buy and options to sell. (For more on the many ways investors use options, please see the Getting Started entry on Options Strategies .)

Buying Options

An option to buy is known as a call; calls are bought when investors think the value of the underlying stock is going to rise. Here's how a call works: An investor pays a premium, which represents a fraction of the value of the underlying investment, for the right to buy a stock at a preset price, known as the strike price, within a given time frame.

After buying the call options, you have two choices. Let's give an example to make it clear what happens with the money. We'll say you bought 10 call options for 100 shares each of XYZ Co. for a premium of $500. The stock's price was $35 a share when you bought the option, and the strike price is $40. The options in this case expire in three months.

Hold the options until maturity (the day they are set to expire), then trade them at the strike price. If the stock is above the strike price, you make money if the difference exceeds your premium. So, if you exercise the option to buy the stock at $45 a share, the 1,000 shares would be worth $5,000 more than the strike price. Subtract the $500 premium, and you made $4,500 (minus fees you pay to your broker). You also have the option to trade the options before it expires, if you're happy with the profit.

Let the options expire without exercising them. Say the stock stays at $35 the whole time, or drops lower, it wouldn't make sense for you to trade them because you would lose thousands of dollars. So, you let the options expire and all you lose is your $500 premium.

Investors also buy options when they think a stock or other security is going to decline in value. An option to sell a stock is called a put. When you buy put options, you buy the right the sell the underlying investment at a set strike price within a given time frame. The way buying put options works is similar to buying calls, except you hope for the underlying investment to go down. If so, you trade for a profit. If not, you swallow the premium.

Selling Options

Selling options works differently. Since the buyer is the one holding the cards, you are obligated to sell if the buyer wants to exercise the options. Investors can sell options to buy and options to sell: If you sell someone the right to buy an underlying investment from you, it is known as writing a call. If you sell someone the right to sell an underlying investment to you, that's called writing a put.

Two common ways to sell calls and puts vary greatly in degree of risk: writing covered options, and writing naked options. When you write a covered call, you are selling someone the right to buy a stock or other underlying investment that you already own at a strike price. When you write a naked call, you sell an investor the right to buy something from you that you don't own.

Naked calls and puts are aptly named, because they leave you exposed to huge downside risk. For instance, if you wrote a naked call allowing someone to buy 1,000 shares of a stock from you at $30 a share, and that stock rises to $35 a share, you have to buy the 1,000 shares at $35 a share, then sell them to the buyer for $30 a share. In other words, getting naked isn't prudent.

Understanding Your Options

Options offer savvy investors a host of ways to play the market, and options trading is a pivotal component of the broader market. Because of these facts, provides both sound advice on options investing with its Options Forum as well as tracking the daily moves in the options market with the Options Buzz column. Meantime, for readers who want to explore their options, take a look at these articles.

An Options Education

Mirror, Mirror, on the Wall, Explain to Me a Put and Call

Cramer's Getting Naked

A Bargain Options Education

Bullish or Bearish Options Trades? Some Clues to Figure It Out

Paying for Options: How Much Is Too Much?

An Options-Owner Instruction Manual

A Short Course on Options Symbols and Expirations

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $94.59 -0.44%
FB $98.07 -1.70%
GOOG $672.40 -1.50%
TSLA $148.45 0.31%
YHOO $26.70 -1.30%


Chart of I:DJI
DOW 15,911.52 -115.53 -0.72%
S&P 500 1,841.68 -11.76 -0.63%
NASDAQ 4,243.4680 -40.2850 -0.94%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs