What Is Options?

An option is a financial contract that gives the buyer the right -- but not the obligation -- to buy or sell an underlying asset (usually a stock) at a specified price (the strike price) within a certain time period. Options come in two types: calls (the right to buy) and puts (the right to sell). Each contract represents 100 shares of the underlying stock.

A call option profits when the stock price rises above the strike price. A put option profits when the stock price falls below the strike price. The price you pay for the option is called the premium. If the option expires without being "in the money" (profitable), you lose the entire premium -- 100% loss. This is why options are considered a high-risk, high-reward strategy.

Options have expiration dates, which adds a time dimension that stocks do not have. An option loses value as it approaches expiration (called time decay or theta). This means you need to be right not only about the direction of the stock but also about the timing. Being right about the direction but wrong about the timing can still result in a total loss.