What an Option Contract Actually Is

An option is an agreement between two people about a price in the future. One pays for the right to do something later. The other takes the money and agrees to be on the hook if it happens. Everything else is detail: which right, at what price, and for how long.

The detail does matter. A contract has four fields, and changing any one of them changes what you have agreed to. Build one below and watch the wording change as you move the pieces.

The four fields

Four things describe any listed option completely. Brokers squash them into one symbol, which is why an option ticker is hard to read until you know where to split it.

The underlying is the stock the contract is about. One contract covers 100 shares of it. The type is either a call or a put, and it decides whether the right is to buy or to sell. The strike price is the price those shares would change hands at. The expiration date is when the contract stops existing.

Pick the wrong strike and you have agreed to a different price. Pick the wrong week and you have agreed to a different amount of time. Both mistakes are easy to make and expensive to undo, so check them on the order ticket rather than after the fill.

The 100 that catches everyone out

Options are quoted per share but traded in lots of a hundred. A screen showing 1.20 does not mean the contract costs $1.20. It means each of the 100 shares it covers costs $1.20, so the contract costs $120.

The multiplier is why options can feel jumpy if you have come from buying shares. A quote going from 1.20 to 1.80 looks like nothing and is $60 a contract, a 50% move. Every dollar figure on this site has already been multiplied out, so the number you see is the number in the account.

Rights and obligations are not symmetrical

The buyer of an option holds a right. They can use it or ignore it, as they like, and if they do nothing the contract expires. The most they can lose is the premium they paid.

The seller holds an obligation. They do not get to choose. If the buyer exercises, the seller has to deliver, whatever the stock has done in the meantime. The most they can make is the premium they collected.

That imbalance is what every income strategy in this course is built on. Sellers get paid cash up front for taking on an obligation that can cost more than the payment. Whether that is a good trade takes up most of the lessons that follow.

Look at the bottom row again. The seller took in $120 and is down $480, but they also own 100 shares. Whether that is a bad day or a normal one comes down to whether they wanted the shares at that price. That is the difference between selling a cash-secured put and gambling.

What can go wrong

Confusing the quote with the cost. The multiplier turns a small-looking number into real money, in both directions.

Selling an obligation you cannot honour. If you sell a $50 put, you need $5,000 available. Your broker may let you sell it on margin without that cash. That is a different and much riskier trade that looks the same on the ticket.

Assuming expiration is the only outcome. Most options get closed before expiry, and American-style contracts can be exercised early. Holding to the last day is a choice, not a rule.