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What Is an Option, in Plain Words

An option is the right, bought for a fee, to buy or sell something at a set price by a set date, with no duty to do so: a call is the right to buy, a put the right to sell, the fee is the premium and the price is the strike. This paper shows what the right is, what a call is worth on the expiry day at every price, how the buyer's and the seller's sides mirror each other, and how an option chain lays strikes and premiums out on a screen. After reading it you can read a call or a put from its strike, premium and expiry, and say what it is worth on the day at any price.

Difficulty
Intermediate
Reading time
5 min
Pages
8
Reviewed by
Saman Rahbar

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An option, in five lines

An option is the right, bought for a fee, to buy or to sell something at a set price by a set date, without any duty to do so. A call is the right to buy; a put is the right to sell. The set price is called the strike, the fee is called the premium, and the date is the expiry. The example through this paper is gold at its real 25 August 2026 price of 4,653.58, and a call with a strike of 4,700, a premium of 60 an ounce and a December expiry. A buyer can lose the premium and no more: 6,000 dollars on a 100-ounce contract. A future is a promise both sides must keep; an option is a right one side may use.

A key with a tag

Picture a key with a price on the tag. The key opens a trade at the tag's price, buying gold at 4,700 an ounce until December, and it cost 60 an ounce to have. If gold is above 4,700 when you look, the door is worth opening. If it is below, you leave the key in a drawer and buy gold in the shop for less. The key was paid for either way, and that fee, the premium, is the whole cost of holding the right. That is the difference from a future, which is a promise that must be kept whatever the price does.

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