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Intermediate · Lesson 1 of 6Calls and puts
An option is a contract giving the buyer the right, but not the obligation, to buy or sell an asset at a set price (the strike) on or before a set date (expiry). The buyer pays a price called the premium to the seller (the writer).
A call gives the right to buy. Buyers of calls profit if the price rises well above the strike. A put gives the right to sell. Buyers of puts profit if the price falls well below the strike, which is why puts are used as insurance.
On the ASX and in the US, one standard equity option contract usually covers 100 shares. The buyer's maximum loss is the premium paid. The writer receives the premium but takes on an obligation, and for an uncovered (naked) call that loss is unlimited.
Key takeaways
- Call = right to buy; put = right to sell.
- Buyer's worst case = premium paid.
- Writers take obligations; naked call writing has unlimited risk.
Check your understanding
1. You buy a put. You profit most if the share price...
- Rises a lot
- Falls well below the strike
- Stays flat
- Pays a dividend
Show the answer
Falls well below the strike. A put gains as the price falls below the strike.
2. The most an option BUYER can lose is...
- Unlimited
- The premium paid
- The strike price
- 100 shares
Show the answer
The premium paid. The buyer can simply let the option expire.
Go deeper
- Wikipedia: Option (finance)
- YouTube videos: options trading for beginners calls and puts explained
- Investopedia: options basics
- ASX: options
- Cboe: options basics
- Moneysmart (ASIC): options
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