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Options in plain words: calls, puts, premium and expiry

Beginner · 7 min read

An option is a contract that gives its buyer a right, and puts an obligation on its seller, for a price called the premium.

• A call (CE) gives the right to buy the underlying at the strike price.
• A put (PE) gives the right to sell the underlying at the strike price.

Index and stock options in India are European-style and settle on expiry. They trade in lots — see lot sizes and leverage.

What happens at expiry

On expiry an option is worth only its intrinsic value: for a call, how far the underlying closed above the strike; for a put, how far below; otherwise zero. Illustration: a 1,000 call bought for ₹20. If the underlying ends at 1,050 the call is worth ₹50 — a ₹30 gain per unit. At 1,015 it is worth ₹15 — still a ₹5 loss. At or below 1,000 it expires worthless and the ₹20 is gone. The breakeven is 1,020.

Buyer and seller are not mirror images in risk

• The buyer's loss is limited to the premium; the gain can be large.
• The seller's gain is limited to the premium; the loss can be large — unlimited on a sold call — and needs much more margin.

Before expiry, the premium also holds time value, which shrinks every day (see time decay).

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Next: Why bought options lose value while you wait (theta) →