Options basics: calls, puts and premium

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Key idea: A call is the right to buy at a set price; a put is the right to sell. The premium is what that right costs, and time drains it every day.

An option is a contract that gives its holder a right, not an obligation. A call option gives the right to buy 100 shares at a set price (the strike) before a set date (expiry). A put gives the right to sell 100 shares at the strike.

The price of the option is the premium. It has two parts: intrinsic value, which is how much the option is worth if used right now, and time value, the extra paid for the chance the share moves further before expiry.

Time value shrinks every day and reaches zero at expiry. This is called time decay. Someone holding an option is fighting the clock; someone who wrote (sold) the option collects it.

Options also have a hidden cost: the gap between the bid and ask price. On thinly traded options that gap can be 10-30% of the premium or more, a cost that is easy to underestimate.

Quick check

A call with a $50 strike costs $4 while the share trades at $52. How much of the premium is time value?

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