Options trading isn’t for everyone, but once you understand the basics, you’ll know if it could be a useful addition to your investment strategy.

By definition: An option is a contract giving the buyer the right but not the obligation to buy (via a “call”) or sell (via a “put”) the underlying asset at a specific price and by a specific expiration date.

• That specific price is called the “strike price.”

What Lies Beneath: Options are traded on everything from stocks and ETFs to bonds and commodities. Stocks are the most common, and 1 option contract represents the right to buy/sell 100 shares of the underlying stock.

Use Case: Some investors use options to generate income, while others do so to hedge risk.

• “Let’s say you’re short on capital, but you have a strong view,” says Imran. “Options give you a way to leverage that capital. You can put $1,000 down, you can have a 3-month view, and you can really participate in the upside if you get it right.”

Price Moves: As the underlying price changes, and as the expiration date approaches, the price of an option contract (aka “the premium”) will move in kind.

• Theoretically, call options gain value when the underlying rises, while put options gain value as the underlying falls.
• But as Imran explains, options are multi-dimensional. “The payoff depends not only on the direction of an asset but also the passage of time, which gives traders a way to take more specific positions.”
• Ultimately, it all comes down to probabilities. The more likely something is to occur, the more expensive an option that benefits from that outcome becomes.

⏳ Time Decay: Always keep the expiration date in mind. An option becomes less valuable as time passes because the probability of a favorable price move continues to diminish.

• Daily, weekly, and monthly expiry dates lose value much faster than contracts with plenty of time until expiration.