A stock trades at 100 dollars. One investor buys 100 shares for 10,000 dollars. Another pays 444 dollars for a call option that gives the right to buy the same 100 shares at 100 dollars at any time in the next 45 days. Six weeks later the stock is at 110. The shareholder is up 1,000 dollars, or 10%. The option holder is up 556 dollars on 444, or 125%. Had the stock ended at 90, the shareholder would be down 1,000 dollars and the option holder down the full 444 dollars, a loss of 100%.
An option is a contract that gives its buyer the right to buy or sell an asset at a fixed price until a fixed date, in exchange for a payment called the premium. The seller of the option collects the premium and takes on the obligation to deliver or take the shares if the buyer uses that right.
The Options Clearing Corporation cleared 15.2 billion contracts in 2025, 24.4% more than in 2024 and about 60.6 million a day.
The terms in an options contract
Every listed option is defined by the same terms, which appear in any broker's option chain.
- Call
- The right to buy the underlying asset at the strike price. A call gains value when the asset rises.
- Put
- The right to sell the underlying asset at the strike price. A put gains value when the asset falls.
- Underlying
- The asset the option refers to: a stock, an ETF or an index.
- Strike price
- The price at which the holder can buy (call) or sell (put). It is fixed when the contract is listed.
- Expiration date
- The last day the right exists. For standard monthly equity options, the last day to exercise is usually the third Friday of the month. Weekly expirations exist on many underlyings, and S&P 500 index options have daily expirations.
- Premium
- The price of the option, quoted per share. One US equity option covers 100 shares, so a premium of 4.44 dollars costs 444 dollars per contract.
- Holder and writer
- The holder buys the option and pays the premium. The writer sells it, receives the premium and carries the obligation. The holder is "long" the option, the writer "short".
- Exercise style
- An American-style option can be exercised on any trading day up to expiration, and all exchange-traded equity options are American-style. A European-style option can be exercised only at expiration. S&P 500 index options (SPX) are European-style and settled in cash, so no shares change hands.
Listed US options are issued by the Options Clearing Corporation (OCC), which processes every exercise and assigns it at random to a clearing member with a short position.
Warren Buffett's description of derivatives as financial weapons of mass destruction, in his 2002 letter to Berkshire Hathaway shareholders, was about the growing volume of long-term derivatives contracts and the uncollateralized receivables growing alongside them. Listed options are issued and cleared by the OCC.
How the examples are priced
All the figures below use one hypothetical stock, XYZ, trading at 100 dollars, with options expiring in 45 days. The premiums come from the Black-Scholes model with an implied volatility of 30% a year and an interest rate of 4%, rounded to the cent. Real quotes also reflect dividends, the bid-ask spread and the volatility the market expects. Commissions and fees are left out.
| Option on XYZ at 100 dollars | Premium per share | Cost of one contract |
|---|---|---|
| 100-strike call | 4.44 | 444 dollars |
| 105-strike call | 2.42 | 242 dollars |
| 100-strike put | 3.95 | 395 dollars |
| 95-strike put | 1.92 | 192 dollars |
A call option, from purchase to expiration
The buyer of the 100-strike call pays 444 dollars. At expiration, the call is worth the amount by which XYZ trades above 100, times 100 shares, and nothing if XYZ is at or below 100. The profit is that value minus the 444 dollars paid.
| XYZ at expiration | Call value | Profit or loss on the call | Profit or loss on 100 shares bought at 100 |
|---|---|---|---|
| 80 | 0 | −444 | −2,000 |
| 90 | 0 | −444 | −1,000 |
| 100 | 0 | −444 | 0 |
| 104.44 | 444 | 0 | +444 |
| 110 | 1,000 | +556 | +1,000 |
| 120 | 2,000 | +1,556 | +2,000 |
The breakeven is the strike plus the premium: 104.44 dollars. Between 100 and 104.44 the buyer loses money although the stock has risen. Above it every dollar of stock gain adds 100 dollars to the contract.
The loss on the call stops at 444 dollars, and the full 444 is lost whenever XYZ ends at or below 100, a flat market included.
The seller of the same call keeps 444 dollars if XYZ ends at or below 100, and loses 1,556 dollars at 120, 4,556 dollars at 150, and more with every further rise. A written call without the shares behind it is called uncovered, or naked, and its maximum loss is theoretically unlimited because a share price has no ceiling.
A put option, from purchase to expiration
The 95-strike put costs 192 dollars. At expiration, it is worth the amount by which XYZ trades below 95, times 100.
| XYZ at expiration | Put value | Profit or loss on the put |
|---|---|---|
| 70 | 2,500 | +2,308 |
| 85 | 1,000 | +808 |
| 93.08 | 192 | 0 |
| 95 or above | 0 | −192 |
The breakeven for a put is the strike minus the premium, here 93.08 dollars. The largest possible gain is reached if XYZ goes to zero: 9,500 dollars of value, or 9,308 dollars of profit. The put buyer bets on a fall and can lose at most 192 dollars. Short selling the shares loses more with every rise in price and pays borrowing fees for as long as the position is open.
The put writer collects 192 dollars and must buy 100 shares at 95 if assigned. If XYZ drops to 80, the writer pays 9,500 dollars for shares worth 8,000 and is down 1,308 dollars after the premium. If XYZ goes to zero, the loss reaches its maximum of 9,308 dollars.
Intrinsic value and time value
Before expiration, an option's premium splits into two parts:
- Intrinsic value is what the option would be worth if exercised now. For a call, it is the stock price minus the strike, if positive. For a put, it is the strike minus the stock price, if positive. Otherwise it is zero.
- Time value, also called extrinsic value, is everything else in the premium: the price of the chance that the option gains more before it expires.
These two parts define the three states traders use to describe an option. A call with a strike below the stock price is in the money and has intrinsic value. A call with a strike above the stock price is out of the money and has only time value. A strike equal or close to the stock price is at the money. For puts the directions reverse.
If XYZ rises from 100 to 101 on the day the 100-strike call is bought, the call is worth about 5.00 dollars in the model. One dollar of that is intrinsic value, and 4.00 is time value.
Time value shrinks as expiration approaches, and it shrinks faster at the end. With XYZ unchanged at 100, the same at-the-money call is worth:
| Days to expiration | Premium per share | Cost of one contract |
|---|---|---|
| 90 | 6.41 | 641 dollars |
| 45 | 4.44 | 444 dollars |
| 5 | 1.43 | 143 dollars |
| 1 | 0.63 | 63 dollars |
Halving the time from 90 to 45 days removes about 30% of the premium. The last day alone removes 63 dollars a contract.
Implied volatility also moves the price. If the market raises its expected volatility for XYZ from 30% to 31%, the 45-day call goes from 4.44 to about 4.58 dollars with no move in the stock.
The four basic positions and their limits
Multi-leg option strategies are built from four basic positions. Their outcomes at expiration, per contract, for options on XYZ:
| Position | View on the stock | Maximum gain | Maximum loss | Breakeven |
|---|---|---|---|---|
| Long 100 call at 4.44 | Rise | Unlimited | 444 dollars | 104.44 |
| Short 100 call at 4.44 | Flat or fall | 444 dollars | Unlimited | 104.44 |
| Long 95 put at 1.92 | Fall | 9,308 dollars | 192 dollars | 93.08 |
| Short 95 put at 1.92 | Flat or rise | 192 dollars | 9,308 dollars | 93.08 |
A short put backed by enough cash to buy the shares is called a cash-secured put. It is how some investors aim to buy a stock below today's price: the writer is paid 192 dollars and buys at 95 if assigned, an effective cost of 93.08. If the stock never falls to 95, the writer keeps the premium and owns nothing.
Covered calls: premium income with a capped upside
A covered call combines 100 shares with one written call on the same stock. The shares "cover" the obligation: if the call is exercised, the writer delivers shares already owned.
Take an investor who buys 100 XYZ at 100 dollars and sells the 105-strike call for 242 dollars. At expiration:
| XYZ at expiration | Shares only | Covered call |
|---|---|---|
| 80 | −2,000 | −1,758 |
| 90 | −1,000 | −758 |
| 100 | 0 | +242 |
| 105 | +500 | +742 |
| 120 | +2,000 | +742 |
| 150 | +5,000 | +742 |
The trade earns 242 dollars more than the shares when the stock ends at or below 105. Above 105 the shares are called away at 105, and the profit stops at 742 dollars, 7.42% on 10,000 dollars in 45 days. At 150 the investor has given up 4,258 dollars of gain in exchange for the premium. The breakeven falls from 100 to 97.58 dollars, which is the full extent of the downside protection.
At Fidelity, selling covered calls is permitted from the first options tier and in IRAs. Under strategy-based margin rules, the short call carries no requirement of its own when the stock is held, and the stock needs the usual 50% initial margin in a margin account.
The call can be assigned on any day before expiration, and assignment risk rises the day before a stock's ex-dividend date, because a call holder may exercise to collect the dividend. A writer who wants to keep the shares can buy the call back before expiration, which costs more than the premium received if the stock has risen.
Protective puts and collars
A protective put is the reverse trade: an investor who owns shares buys a put to limit the loss. With 100 XYZ bought at 100 and a 95-strike put bought for 192 dollars:
- At 70, the shares lose 3,000 dollars, the put pays 2,500, and the net loss is 692 dollars.
- At 95 or below, the net loss is always 692 dollars: 500 of price decline plus the 192-dollar premium.
- At 100, the loss is the 192-dollar premium.
- At 120, the gain is 1,808 dollars, the 2,000 of the shares minus the premium.
The put works like an insurance policy with a 5% deductible. Its price, 192 dollars for 45 days, is 1.92% of the position. Renewed eight times a year at a similar price, the protection would cost about 15% of the position a year.
Combining the two trades gives a collar: the investor owns the shares, buys a put and sells a call, so the call premium pays part or all of the put. The position has a floor and a ceiling.
The Greeks, measured on one contract
The Greeks describe how an option's price reacts to one input changing while the others stay fixed. For the 45-day, 100-strike XYZ call at 4.44 dollars:
- Delta: 0.54
- The option gains about 0.54 dollars per share, or 54 dollars per contract, for a one-dollar rise in XYZ. Call deltas run from 0 to 1, put deltas from −1 to 0. The at-the-money 100-strike put here has a delta of −0.46. Delta is also used as a rough estimate of the probability that the option ends in the money.
- Gamma: 0.038
- Delta itself rises by about 0.038 for each one-dollar rise in XYZ. Gamma is highest for at-the-money options near expiration. With one day left, the same call's gamma is 0.254, so delta can swing from near 0 to near 1 within a small move.
- Theta: −0.052
- The option loses about 5.2 cents per share, 5.20 dollars per contract, per calendar day if nothing else changes. With one day left, theta on the same call reaches −0.32.
- Vega: 0.139
- The option gains about 14 cents per share for each one-point rise in implied volatility, which is the move from 4.44 to 4.58 described above.
- Rho
- The change in price for a one-point change in interest rates. It is small for short-dated options and matters mainly for long-dated contracts, called LEAPS.
A writer holds the same Greeks with the opposite sign. The seller of this call is short 54 deltas, collects 5.20 dollars a day of theta and loses when volatility rises.
Exercise, assignment and expiration day
Historically, more than 72% of contracts are closed out by an offsetting trade before expiration, about 22% expire worthless, and about 6% are exercised. Selling an option that has gained value collects its remaining time value, which exercising would throw away.
When a holder does exercise, the OCC assigns the notice at random to a clearing member with a short position in that series, and the broker passes it on to one of its customers who wrote the option. FINRA Rule 2360 requires brokers to allocate these notices on a first-in, first-out basis or by random selection, and to tell customers in writing which method they use.
At expiration, the OCC applies a procedure called exercise by exception: an equity option that is in the money by $0.01 or more is exercised automatically unless the clearing member instructs otherwise. A holder of five in-the-money calls on a 100-dollar stock who does nothing on expiration Friday wakes up owning 500 shares worth 50,000 dollars. Brokers can apply their own thresholds, and some reserve the right to close in-the-money positions on expiration day when the account cannot support the exercise or assignment. A holder can give the broker an explicit instruction to exercise or not before its cutoff time.
Early assignment affects only American-style options. The writer of a covered call can lose the shares before expiration, and the writer of a short put can be assigned shares at any time. Cash-settled index options like SPX settle only at expiration and deliver a cash amount.
Broker approval levels and FINRA Rule 2360
A broker must approve the account for a specific level of options trading, and the levels follow the risk of the strategy. Fidelity uses three tiers:
- Tier 1: covered calls, buy-writes, buying calls and puts, cash-secured puts, long straddles and strangles.
- Tier 2: everything in Tier 1, plus spreads of up to four legs and covered puts secured by short stock.
- Tier 3: everything in Tier 2, plus selling uncovered calls and puts and short straddles.
Other brokers number the same ladder differently. Merrill places covered calls at level 1, cash-secured puts at level 2 and credit spreads at level 4.
Under FINRA Rule 2360, the firm must seek, for an individual, at least the customer's investment objectives, employment status, annual income, net worth excluding the home, liquid net worth, marital status and dependents, age, and experience with options, stocks, bonds and commodities. A branch manager or a Registered Options Principal approves or refuses the account in writing, and where the branch manager is not a Registered Options Principal, one must sign off within ten business days. The firm must send the customer the background and financial information for verification within fifteen days.
Before the account is approved, the customer must receive the options disclosure document, Characteristics and Risks of Standardized Options, published by the OCC. Approval for uncovered writing carries extra requirements under the same rule: written approval by a Registered Options Principal, a minimum net equity set by the firm and a special written statement on the risks of uncovered writing, delivered before the first uncovered trade.
The SEC approved the removal of FINRA's pattern day trader designation and its $25,000 minimum equity requirement on April 14, 2026, effective June 4, 2026. An intraday margin standard replaces it, and firms have until October 20, 2027 to implement it, so a broker may still enforce the old limit in the meantime.
Margin on written options
A holder pays the premium in full, and for options expiring within nine months, no borrowing is allowed against the purchase. A writer of an uncovered equity option must post the premium received plus 20% of the value of the underlying shares, minus the amount by which the option is out of the money, with a floor of the premium plus 10% of the share value for calls or 10% of the strike value for puts.
For the uncovered 95-strike XYZ put, with the stock at 100:
- Premium: 192 dollars.
- 20% of the share value: 2,000 dollars.
- Minus the out-of-the-money amount: 500 dollars.
- Requirement: 1,692 dollars, above the 1,142-dollar floor.
The requirement is recalculated every day at the option's market value. If XYZ falls to 85, the put is 1,000 dollars in the money and the requirement rises to about 2,730 dollars: roughly 1,030 dollars of option value in the model plus 1,700 dollars, 20% of the 8,500-dollar share value. Brokers may set their own requirements above these minimums.
How options are taxed in the US
For investors who are not dealers, the federal rules work as follows:
- Option bought and sold: the gain or loss is a capital gain or loss, long-term or short-term depending on how long the option was held.
- Option bought and left to expire: its cost is a capital loss, with the holding period ending on the expiration date.
- Call bought and exercised: the premium is added to the cost basis of the shares. The XYZ call exercised at 100 gives a basis of 10,444 dollars for 100 shares.
- Put bought and exercised: the premium reduces the amount realized on the sale of the shares.
- Option written that expires: the premium is a short-term capital gain, whatever the time held.
- Option written and bought back: the difference is a short-term capital gain or loss.
- Call written and exercised: the premium is added to the sale price of the shares, and the holding period of the shares decides whether the gain is long-term.
- Put written and exercised: the premium reduces the cost basis of the shares bought, and their holding period starts on the purchase date.
Three special rules apply. Buying a put on shares held for one year or less is treated as a short sale, and the holding period of the shares starts over when the put is exercised, sold or expires. Buying a call on a stock within 30 days of selling it at a loss can trigger the wash sale rule, which covers any "contract or option to buy substantially identical stock". And broad-based index options such as SPX are section 1256 contracts: they are marked to market at year end and taxed 60% as long-term and 40% as short-term gain, whatever the holding period. Stock and ETF options do not get that treatment.
Stock held with an offsetting put can also form a straddle, whose loss deferral rules are set out in the same publication.
0DTE options and retail trading results
Zero-days-to-expiration options, or 0DTE, are contracts traded on the day they expire. On the S&P 500 index, where Cboe lists expirations every trading day, they made up 59% of SPX volume in 2025, a record 2.3 million contracts a day.
In the XYZ example, a one-day at-the-money call costs 63 dollars a contract, against 444 dollars for 45 days. Its gamma is 0.254, so a two-dollar move in XYZ shifts its delta by about half, and whatever is out of the money at the close expires at zero.
More than 75% of retail trades in S&P 500 index options involve 0DTE contracts, and those traders lose money in aggregate despite paying lower effective spreads. Across all listed options, retail investors favor cheaper, weekly options with an average bid-ask spread of 12.6% and lose money on average.
A 2025 study by Amaya, Garcia-Ares, Pearson and Vasquez, supported by a Cboe data grant, measured performance at expiration using Cboe trade directions and found that customer trades in single-leg price improvement auctions on Cboe were profitable on average. The studies disagree on how to tell whether a trade was a purchase or a sale and on when to measure its value.
Overconfidence and the other behavioral biases that lead investors to trade too often have been measured on stock trading. A 0DTE contract can be opened and closed several times in a single session.
The risks of selling options
Buying an option limits the loss to the premium. A written option collects a fixed premium and can lose many times that amount:
- Uncovered calls: the 105-strike XYZ call sold for 242 dollars loses 4,258 dollars if XYZ reaches 150 at expiration, and 9,258 dollars at 200. A takeover bid or a short squeeze can move a stock that far overnight, and the writer cannot exit while the market is closed.
- Uncovered puts: the 95-strike put sold for 192 dollars loses up to 9,308 dollars. Puts written on ten different stocks are all exposed to the same broad market fall.
- Margin calls: requirements rise with the loss, so the broker may close positions at market prices if the account runs short.
- Assignment timing: an American-style short option can be assigned on any day, including just before an ex-dividend date.
Buyers face their own risk: the whole premium can go to zero, and in the XYZ call example a flat stock is enough to lose 100% of the money invested.
A hedge fund can write uncovered options and borrow far more than a mutual fund, and the rules that separate the two are set out in hedge funds vs mutual funds.
This article is general information and does not constitute investment advice.
Frequently asked questions
Can you trade options with $100?
Yes, if the broker has approved the account for options and the premium fits. A listed stock option covers 100 shares, so an option quoted at $0.80 costs $80 plus fees. Cheap options are usually far out of the money or close to expiration, which means they are more likely to expire worthless. Selling options needs far more capital, because the account must hold the shares, the cash to buy them or the margin set by FINRA and the exchanges.
Do you still need $25,000 to day trade options?
No longer under FINRA rules. The SEC approved the removal of the pattern day trader designation and its $25,000 minimum equity requirement on April 14, 2026, with effect from June 4, 2026. An intraday margin standard replaces it, and firms have until October 20, 2027 to implement the new rule, so some brokers still apply the old limit during the transition.
Do most options traders lose money?
Several academic studies find that retail options traders lose money on average. A 2023 Journal of Finance paper measured an average spread of 12.6% on the options retail investors prefer. A 2025 study using Cboe data found the opposite for customer trades executed in price improvement auctions on Cboe exchanges. The answer depends on how retail trades are identified and on whether performance is measured at expiration.
What happens if I do nothing when my option expires?
An equity option that is in the money by $0.01 or more at expiration is exercised automatically by the Options Clearing Corporation unless your broker submits contrary instructions. A call then buys 100 shares per contract and a put sells 100 shares, which can create a stock position the account cannot pay for. An option that is out of the money expires worthless. Brokers may apply their own thresholds, and a holder can send the broker explicit exercise instructions before its cutoff.
What did Warren Buffett say about options and derivatives?
In his 2002 letter to Berkshire Hathaway shareholders, Buffett called derivatives financial weapons of mass destruction. His concern was large, long-term and uncollateralized derivative contracts between institutions, which carry counterparty risk. Exchange-listed options are issued and cleared by the Options Clearing Corporation.
Is a covered call risk free?
No. A covered call keeps almost all of the downside of owning the stock, reduced only by the premium received, and caps the upside at the strike price. In the example in this article, a stock bought at $100 with a $105 call sold for $2.42 loses $758 per 100 shares if the stock falls to $90, and earns at most $742 however high the stock rises.