Options 101: Calls, Puts, and How Contracts Work

A technical but accessible intro to options, covering contracts, strikes, expiration, intrinsic vs extrinsic value, and payoff diagram math.

By Michael Hewitt, Founder & Editor-in-Chief. Updated September 29, 2026.

The first expensive mistake in options is not picking the wrong stock. It is reading the quote as the price. Every contract covers 100 shares, so a $100-strike call quoted at $3.00 costs $300: worth $1,000 if the stock finishes at $110, and nothing if it sits at $100. That asymmetry is why the beginner rules are narrow: liquid underlyings, 30 to 60 days to expiration, and 2 to 3% of the account per trade at most until you have 30 or more live trades behind you. On a $10,000 account, 2% is $200: one contract quoted at $2.00.

What an Options Contract Is

An options contract gives the buyer the right, but not the obligation, to buy or sell 100 shares of a stock at a specific price, on or before a specific date. The seller of the contract takes on the obligation in exchange for the premium paid upfront.

• Call option: right to BUY 100 shares at the strike price. Bullish bet.
• Put option: right to SELL 100 shares at the strike price. Bearish bet or hedge.
• Strike price: the agreed-upon buy/sell price written into the contract.
• Expiration: the last day the option can be exercised. Weekly, monthly, quarterly, or LEAPS (1-3 years).
• Premium: the price to buy or sell the contract, quoted per share (×100 for dollar cost).

Intrinsic Value vs Extrinsic Value

Every option's premium breaks down into two components.

• Intrinsic value: how much in-the-money the option is RIGHT NOW. A $100 call with stock at $105 has $5 of intrinsic value.
• Extrinsic value (time value): everything else. It decays to zero at expiration.
• In-the-money (ITM): call strike below stock price, or put strike above stock price. Has intrinsic value.
• Out-of-the-money (OTM): call strike above stock price, or put strike below stock price. All premium is extrinsic.
• At-the-money (ATM): strike near current price. All premium is extrinsic; highest time value.

The Call Option Payoff: Worked Example

Assume XYZ trades at $100. You buy the 30-day $100 call for $3.00 ($300 per contract). Your max loss is $300 (the premium). Your break-even at expiration is $103 (strike + premium).

• At $95 at expiry: call expires worthless. Loss: -$300 (-100%).
• At $100 at expiry: call expires worthless. Loss: -$300 (-100%).
• At $103 at expiry: intrinsic value is $3, matching premium. Break-even ($0).
• At $110 at expiry: intrinsic value is $10. Profit: $700 per contract (+233%).
• At $120 at expiry: intrinsic value is $20. Profit: $1,700 per contract (+567%).
• Above $100 before expiry: profit also includes remaining time value.

The Put Option Payoff: Worked Example

Same XYZ at $100. You buy the 30-day $100 put for $2.80 ($280 per contract). Max loss is $280. Break-even at expiration is $97.20 (strike - premium).

• At $105 at expiry: put expires worthless. Loss: -$280.
• At $100 at expiry: put expires worthless. Loss: -$280.
• At $97.20 at expiry: break-even.
• At $90 at expiry: intrinsic value is $10. Profit: $720 per contract (+257%).
• At $80 at expiry: intrinsic value is $20. Profit: $1,720 per contract (+614%).
• The put's max theoretical gain is capped at (strike × 100 - premium) if stock goes to zero.

Writing (Selling) Options: The Other Side of the Trade

When you buy a call or put, someone is writing it to you. Writers collect the premium upfront but take on the obligation to buy or deliver shares if exercised. The risk profile flips.

• Covered call: sell a call against 100 shares you already own. Max profit: premium + (strike - cost basis). Risk: capped upside if stock rallies past strike.
• Cash-secured put: sell a put and hold cash equal to 100 × strike. Max profit: premium. Risk: forced to buy 100 shares at strike if assigned.
• Naked call: sell a call without owning shares. Unlimited loss potential. Requires high-tier options approval and significant margin.
• Naked put: sell a put without cash to buy shares. Loss capped at strike × 100 - premium (stock can only go to zero).
• Assignment: if the option is in-the-money at expiration (or earlier, on American-style options), the buyer can exercise and the writer must deliver shares (call) or buy them (put) at the strike price.

Assignment, Exercise, and Settlement

• Exercise: the option buyer elects to buy (call) or sell (put) 100 shares at the strike. Usually happens at or near expiration when ITM.
• Assignment: the Options Clearing Corporation assigns exercises to brokers at random, and each broker picks among its customers short that contract. Only closing the contract prevents it.
• Early assignment: American-style options (most single-name stocks) can be assigned any time before expiration. European-style (index options like SPX) can only be assigned at expiration.
• Automatic exercise: brokers auto-exercise any option $0.01+ ITM at expiration unless you instruct otherwise.
• Pin risk: when stock closes very near the strike at expiration, assignment can be unpredictable. Close positions before expiration to avoid it.
• Dividends: call writers risk early assignment the day before an ex-dividend date if the call is deep ITM. Check ex-div calendars.

Key Takeaways

• One contract covers 100 shares, so the dollar risk is always the quoted premium times 100.
• Extrinsic value decays to zero by expiration: buyers pay theta; sellers collect it and carry the tail risk.
• Implied volatility moves prices as much as the stock does: sell premium when IV rank is above 50, buy below 30.
• Until you have 30 or more live trades, stick to liquid underlyings, 30 to 60 DTE, and 2 to 3% of the account per trade.