Options — The Right But Not the Obligation

Calls, puts, strike prices, expiry dates and the payoff diagram that explains everything

10 min read Intermediate

"An option gives you the right to buy or sell an asset at a fixed price before a set date. You do not have to use it. That asymmetry — right but not obligation — is what makes options both useful and dangerous."

For educational purposes only. Nothing in this chapter is financial advice. All figures are illustrative examples. Tax rules, account types, contribution limits, and regulations differ by country and change over time. Always verify current rules with official government sources or a qualified financial adviser before making any investment decisions.

What an Option Is

An option gives you the right — but not the obligation — to buy or sell an asset at a fixed price (the strike price) before or on a set date (the expiry). You pay a premium for this right. If you choose not to use it, you lose only the premium.

Call option

Right to buy at the strike price. Profitable when the underlying rises above the strike + premium paid. Example: buy a call on a £50 stock with £52 strike for £1.50 premium. Profitable if stock exceeds £53.50.

Put option

Right to sell at the strike price. Profitable when the underlying falls below the strike − premium paid. Used as insurance on existing holdings.

Key Terms

Strike price

The fixed price at which you can buy (call) or sell (put) the underlying asset.

Expiry date

The date on which the option expires. American-style options can be exercised any time before expiry. European-style only at expiry.

Premium

The price you pay to buy the option. This is your maximum loss if you are buying options.

In the money (ITM)

A call is ITM when the asset price is above the strike. A put is ITM when below. ITM options have intrinsic value.

Out of the money (OTM)

The option has no intrinsic value — only time value. It will expire worthless if the price does not move in your favour.

IV (Implied Volatility)

The market's expectation of future volatility, baked into the option price. High IV = expensive options.

The Payoff Asymmetry

When you buy an option: maximum loss is the premium paid. Maximum gain is theoretically unlimited (calls) or the strike price (puts). This asymmetry is why options appeal to buyers.

When you sell (write) an option: you receive the premium upfront. But your maximum gain is just that premium, while your potential loss can be very large — or unlimited for naked calls. Selling options without owning the underlying is how retail traders blow up accounts.

The naked call risk

Selling a call without owning the underlying means you must deliver shares at the strike price if exercised. If the stock triples, your loss is theoretically unlimited. This is one of the few strategies with no defined maximum loss.

FAQs

Can I lose more than I invest with options?

If you are buying options: no. You can only lose the premium. If you are selling options (especially naked): yes. Losses can far exceed the premium received.

What is a covered call?

Selling a call on shares you already own. If exercised, you sell your shares at the strike price. You keep the premium regardless. This is one of the lower-risk options strategies.

Why do options lose value over time?

Time decay (theta). Each day that passes, the option has less time to move in your favour. All else equal, options lose value as they approach expiry. Buyers fight time decay; sellers benefit from it.

Are options available in an ISA?

Standard ISAs do not permit options trading. You need a general investment account or a specialist derivatives account.

What does "options expiring worthless" mean?

If the underlying price never reaches your strike price before expiry, the option expires worthless. The buyer loses the premium; the seller keeps it.

Key takeaways

A call option gives the right to buy; a put gives the right to sell — at a fixed price before expiry.
Option buyers: maximum loss is the premium paid. Gain is theoretically unlimited.
Option sellers: maximum gain is the premium received. Loss can be very large or unlimited.
Time decay erodes option value daily — buyers are fighting the clock, sellers benefit from it.
Covered calls (selling calls on shares you own) are one of the lower-risk options strategies.