What Are Option Strategies?
Option strategies are structured ways of trading options, alone or in combination, to match a specific market opinion.
An option is a contract that gives the option holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a set expiration date. The underlying asset can be a stock, one of many exchange traded funds, or an index. Every strategy above is built from that same contract. Here is how the pieces work.
Options Trading Basics: Calls and Puts
There are only two types of options. Everything else is a combination.
The Call Option
A call option gives the buyer the right to purchase the underlying stock at a fixed price, called the strike price, before the option expires. The call buyer pays a premium for that right. All else being equal, a call gains value as the stock price rises, provided the move comes fast enough to outrun time decay. And when the stock trades above the strike, the call is in the money, meaning the option holder could buy shares below the prevailing market price. If the stock price falls or sits still, the call contract loses value as time passes, and it can expire worthless.
The Put Option
A put option is the mirror image. It gives the holder the right to sell the underlying security at the strike price. All else being equal, a put gains value when the stock price falls and loses value when the stock price increases. But all else is rarely equal. Time decay and implied volatility move the option price too, and a slow drift lower can still leave a put buyer underwater. Traders buy puts to profit from downside price movements or to protect stock they already own.
You can be a buyer or a seller of either one. Buying an option means paying a premium for rights. Selling options means collecting premium in exchange for taking on obligations, and it carries its own risks, which I cover in detail in my guide to selling naked calls and puts. That opening transaction, buy or sell, defines your risk before anything else does.
How Options Are Priced: Premium, Intrinsic Value, and Time Value
The option price, called the premium, has two parts.
Intrinsic value is what the option is worth if exercised right now. For a call, it is the current market price of the stock minus the strike price. For a put, it is the strike price minus the current price. If that math produces a negative number, intrinsic value is zero.
Time value is everything above intrinsic value. It reflects how much time remains until the expiration date, how volatile the underlying stock is, and current market conditions. Volatility is the piece most traders underestimate, and it comes in more than one flavor. I break down the differences in implied vs realized vs historical volatility. Time value melts away every day the option exists, which is exactly why so many options expire worthless. As a broker I watched thousands of traders pay too much premium for too little time, and it is still the most common mistake in the options market. At the extreme end of the time spectrum are 0DTE options, contracts that expire the same day you trade them, where time decay happens in hours instead of weeks.
Your breakeven always includes the price paid. A call needs the stock above the strike plus the premium paid. A put needs the stock below the strike minus the premium. If the option expires worthless, that premium is the maximum loss for the buyer and the maximum profit for the seller who collected it. If you want to see these numbers before you trade, run the position through our free option calculators.
Key Terms Every Options Trader Should Know
Learn these key terms cold before you place a trade. They show up in every strategy guide above.
| Term | What It Means |
|---|
| Strike price | The specific price where the option can be exercised. Also called the exercise price. |
| Premium | The price paid by the buyer and the premium received by the seller. |
| Expiration date | The last day the options contract exists. |
| Exercise | When the buyer exercises the right to buy or sell the underlying instrument. |
| Assignment | The seller's obligation to deliver when the buyer exercises. |
| Cost basis | Your effective purchase price on shares after option premium is factored in. |
| Short position | An options position opened by selling a contract you did not already own. |
| The Greeks | Delta, gamma, theta, and vega. The numbers that measure how an option price moves. Full breakdown on our Option Greeks page. |
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