When are stock options vested?

With some option grants, all shares vest after just one year. With most, however, some sort of graduated vesting scheme comes into play. For example, 20% of the total shares are exercisable after one year, and 20% after two years and continuing.

What is the difference between a call and a put option?

A call option gives you the right to buy a stock, while a put option gives you the right to sell a stock.

How do I calculate the value of a stock option?

Stock options have complicated valuations that take into account the price and volatility of the underlying stock and the time remaining until expiration. The intrinsic value of an option is the difference between the value of the underlying stock and the option's strike price, while its time value varies depending on how long it has until it expires.

What are the risks involved in trading stock options?

There are numerous risks involved with trading options. The first is that you can lose all of your principal, or perhaps even more, if you use an aggressive strategy like selling a naked put. The time factor of options means that they lose value every day they creep towards their expiration dates, leaving you vulnerable to losses if the underlying stock doesn't move in a given time frame. Volatility can increase the premium you have to pay for options, putting more of your capital at risk. Advanced options strategies can be so complex that it can be hard to even know when you will turn a profit on a trade, making them inappropriate for novice investors.

Can I make money with stock options if I don't own the underlying stock?

Yes, you can make money from options without owning the underlying stock. This would be a speculative purchase that a stock price would either go up, in the case of a call option or go down, in the case of a put option.

How long do stock options last?

Stock options expire over a variety of time periods, from as short as one day to as long as a few years. Most expire in a few days, weeks or months. However, long-term equity anticipation securities, or LEAPs, typically have expiration dates of one year or longer.

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What Are Stock Options and How Do They Work?

February 25, 2025

6 min Read

Written by John Csiszar

Edited by Nupur Gambhir

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Stock options are leveraged instruments that derive their value from an underlying security, such as a stock. This makes them different from stocks, which are perpetual in nature and represent an ownership stake in a company. Options can serve investors in a number of ways. Speculators can use them to gain from movements in an underlying stock, whether upwards or downwards. They can also be used to hedge portfolios. But while their operations are simple in concept, they can also be quite complex. In some cases, investors can lose not only their entire investment, but even more than they originally put at risk. For this reason, it’s important to fully understand how they operate. Here’s what you’ll need to know.

Understanding Stock Options

What Is a Stock Option?

A stock option is a contract giving its holder the right, but not the obligation, to buy or sell a stock at a given price before a specific date. There are two main types of stock options: call options and put options. They can be used in either conservative or aggressive ways, but they all carry risks.

How Do Stock Options Work?

There are three basic terms that apply to all options: strike price, expiration date, and premium.

The strike price is the price that you can execute the option at, whether you are a buyer or seller. For example, if you buy a call option for Microsoft with a strike price of 400. This gives you the right to buy 100 shares of Microsoft at a price of $400 per share, regardless of where it trades in the market.

The expiration date is when the option will expire worthless, if it isn’t exercised first. For example, if your Microsoft call option with a strike price of 400 has a March 21 expiration date, you have until to sell or exercise the option, otherwise it will expire.

An option premium is the amount you buy or sell an option for. As each option controls 100 shares, you must multiply the premium by 100 to determine the actual cost. If the above Microsoft option trades at $5, for example, the option premium is $500. If you buy an option with a premium of $5, it will cost you $500. If you sell such an option, you will receive $500.

Types of Stock Options

Call Options

A call option gives you the right — but not the obligation — to buy a stock at a set price. In its most basic form, it’s a good instrument to use if you believe that a stock’s price will rise. This is because options are leveraged. For a relatively small amount of money, you can earn a high rate of return if you’re right that a stock will move upwards in a short period of time. If a stock gains 20% in a month, for example, a call option could easily double in price.

Put Options

A put option is the polar opposite of a call option, giving you the right to sell a stock at a certain price before a certain date. You can use put options to earn big gains if you think a stock is going to fall in price over a short period of time. For example, if you buy a Microsoft put option with a strike price of 400, you can sell Microsoft shares at $400 even if the shares fall to $300 in the marketplace.

How To Buy and Sell Stock Options

Buying and selling stock options is somewhat like trading stocks. Here’s what you’ll need to do.

Step 1: Open a Brokerage Account

Choose a broker that offers options trading. Most online brokerages now offer options trading for zero commissions, with perhaps a small per-contract fee. However, not all do, so be sure to check before you open an account.

Step 2: Choose Your Options

Stocks have a large number of options related to them, and more are continually created. Be sure to pick the right strike price, expiration date, and type of options — call or put — before you enter your order.

Step 3: Monitor Your Positions

Keep an eye on the stock’s price and the option’s time decay. Remember that even if a stock doesn’t change its price, an option can lose value due to time decay as its expiration date gets closer and closer.

How To Make Money with Stock Options

Buying Call Options

If you’re of the belief that a stock will go up in price in the near future, you can gain more through the purchase of a call option rather than simply owning the stock. This is because an option is leveraged, and a small outlay of cash can lead to a high percentage gain if you’re correct. For example, if a stock goes from $30 to $40, you have a 33% gain, but a short-term call option on that stock will likely more than double in value.

Buying Put Options

Put options are often used as hedges against long stock positions. If you think the stock market is going down, for example, but you don’t want to sell your stock, you can buy a put option against it. If the stock does indeed fall in price, you get to keep the premium you received from selling the put option to help offset your losses in the stock.

If you think a stock that you don’t own will fall in value, you can also make money by buying a put option. If you buy a put with a strike price of 400 and the underlying stock drops in value to $300 per share, you’ll profit $100 per share, or $10,000.

Using Options as a Hedge

Buying put options against stocks you already own can be a good way to protect your portfolio from market downturns. This is because put options gain in value — at a leveraged rate — when their underlying stocks drop in value. In fact, you may even make money during a market decline if you properly hedge your portfolio with put options. A 10% drop in an individual stock, for example, could lead to a gain of 50% or more in a put option, more than offsetting your portfolio losses. If you’re wrong and the market goes up, you’ll only lose the premium you paid for the hedge, and the gain in your underlying stocks will offset or even exceed the amount of money you lost.

Stock Options vs. Stocks

Key Differences

The primary difference between options and stocks is this: stocks represent ownership in a company and last perpetually, while options are contracts for potential future transactions that have a finite life. You can never lose more than you invest in a single stock, but with certain options transactions, you can owe more than you originally invested.

When To Use Each

Stocks are the preferred vehicle for long-term growth, whereas options are best suited for short-term strategies. This is due in part to the fact that stocks never “expire,” as options do. Thus, at least in terms of basic call and put options, an option should only be used when a trader has a conviction that something will occur in the near future, before the option starts losing its time value.

John Csiszar contributed to the reporting for this article.

Information is accurate as of Feb. 25, 2025.

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