{"id":65219,"date":"2025-09-21T02:00:32","date_gmt":"2025-09-21T07:00:32","guid":{"rendered":"https:\/\/www.tradestation.com\/insights\/?p=65219"},"modified":"2025-09-19T09:27:49","modified_gmt":"2025-09-19T14:27:49","slug":"the-basics-of-options-2","status":"publish","type":"post","link":"https:\/\/www.tradestation.com\/insights\/2025\/09\/21\/the-basics-of-options-2\/","title":{"rendered":"The Basics of Options"},"content":{"rendered":"\r\n

Options are an important tool for many retail investors. They can either replace trading shares, or make it easier to position oneself in stocks. Let\u2019s consider the first things options traders need to know.<\/p>\r\n\r\n\r\n\r\n

An Option\u2019s Price Is Usually Called \u2018Premium\u2019<\/h3>\r\n\r\n\r\n\r\n

There are some historical reasons for this but they\u2019re not very interesting. Just remember that you\u2019ll hear the term \u201cpremium\u201d used all the time with the price of options.<\/p>\r\n\r\n\r\n\r\n

Options Derive Their Value From Stocks<\/h3>\r\n\r\n\r\n\r\n

Options<\/a>\u00a0give you a right or obligation to buy or sell a stock at a certain price over a certain time period. As a result, premiums are based heavily on the value of the underlying shares. (Called \u201cunderliers.\u201d) Because they\u00a0derive\u00a0<\/em>their price from something else, options are\u00a0derivatives<\/em>.<\/p>\r\n\r\n\r\n\r\n

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Calls Generally Appreciate When Prices Rise<\/h3>\r\n\r\n\r\n\r\n

Calls fix the price where you can buy a stock. That makes their premiums increase when the shares go up.<\/p>\r\n\r\n\r\n\r\n

They\u2019re like a coupon saying you can buy a cup of coffee for $0.99. If the full price is $2.99, then it\u2019s easy to see that the coupon itself is worth at least $2. It\u2019s also pretty clear that the coupon would gain value if the cup of coffee rose to $4.99.<\/p>\r\n\r\n\r\n\r\n

Puts Generally Appreciate When Prices Fall<\/h3>\r\n\r\n\r\n\r\n

Puts fix the price where you can sell a stock. That makes their premiums increase when the shares go down.<\/p>\r\n\r\n\r\n\r\n

Say an investor owns a stock worth $80 but the puts give him or her the right to sell for $100. It\u2019s not hard to see the puts are worth at least $20, and gain value if the stock falls.<\/p>\r\n\r\n\r\n\r\n

Options Owners Control 100 Shares<\/h3>\r\n\r\n\r\n\r\n

A single call gives you the right to buy 100 shares of the underlier. A single put conveys the right to sell 100 shares.<\/p>\r\n\r\n\r\n\r\n

Options are quoted on a per-share basis, but the real cost is 100 times greater. For example, purchasing a single contract of a $0.50 call or put actually costs $50.<\/p>\r\n\r\n\r\n\r\n

Options Have Leverage<\/h3>\r\n\r\n\r\n\r\n

These examples also show how options can generate leverage. If the cup of coffee rises from $2.99 to $3.99, it\u2019s a 33 percent gain. However the calls would appreciate from $2 to $3, or 50 percent.<\/p>\r\n\r\n\r\n\r\n

In the case of the puts, the stock might drop from $80 to $70, or 12.5 percent. But the puts would increase from $20 to $30, or 50 percent.<\/p>\r\n\r\n\r\n\r\n

In both cases the options change in value more than the underlier. This leverage is a reason why a lot of people like trading calls and puts.<\/p>\r\n\r\n\r\n\r\n

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Leverage Is a Risk<\/h3>\r\n\r\n\r\n\r\n

Options\u2019 leverage can be a significant risk when the stock moves in the \u201cwrong\u201d direction.<\/p>\r\n\r\n\r\n\r\n

If the cup of coffee drops by 50 percent from $2.99 to $1.49, the calls would plunge from $2 to $0.49 \u2013 more than 75 percent.<\/p>\r\n\r\n\r\n\r\n

Likewise the puts generally lose value when prices rise. If the stock in question rises barely 10 percent from $80 to $90, then the puts drop by 50 percent to $10.<\/p>\r\n\r\n\r\n\r\n

Time and Volatility Also Impact Premiums<\/h3>\r\n\r\n\r\n\r\n

Aside from the underlier\u2019s price,\u00a0time<\/em>\u00a0and\u00a0volatility\u00a0<\/em>impact the value of an option.<\/p>\r\n\r\n\r\n\r\n

We\u2019ll explore this more in another post. But simply put, you need to know two things:<\/p>\r\n\r\n\r\n\r\n