has a "100 multiplier". It is good for 100 shares of stock -- so an option that finished in-the-money by $10 would allow you to make $10 on 100 shares of stock, or $1000, not just $10)

Jack (the seller of the option), on the other hand would have the OBLIGATION to sell Jill ABC stock at the price of $110 dollars, $10 LESS than he could sell it in the marketplace. This represents, in terms of opportunity cost, a $10 loss to Jack.

This potential risk that Jack assumes when selling the option to Jill

The Basics

Calls: A call is the right to buy stock for a certain, predetermined price. This right exists up until a specified expiration date, at which point the right to buy is forfeited.

Puts: A put is the right to sell stock at a certain, predetermined price. This right exists up until a specified expiration date, at which point the right to sell is forfeited.

How does it work?

An option is a contract between two parties, the buyer and the seller (or writer) or the option. The buyer is purchasing the right to buy or sell stock at the predetermined price within the timeframe specified in the contract. The seller is giving the buyer the right to buy stock from the seller, or sell stock to the seller at the specified price. Should the buyer CHOOSE to exercise his right, it is the OBLIGATION of the option seller to fulfill that request. The buyer has no obligations to the seller.

So in each contract, the buyer has the OPTION to exercise, and the seller has the OBLIGATION to fulfill the request, if the buyer chooses to exercise.

Example: Jack Sells ABC 100 Call to Jill

Consider the case of stock ABC, trading at $100. Jack sells a $110 call (the right to buy stock for the price of $110) to Jill. Jill now has the right to purchase ABC stock from Jack, for the price of $110. Jill, obviously would not choose to exercise this right today, as she could easily buy ABC stock from the marketplace for $100, instead. However, if tomorrow, the price of ABC shoots up to $120, Jill may choose to exercise her RIGHT to buy ABC for $110. Doing so, Jill would be effectively buying ABC stock at a $10 discount to the market. We would say that ABC is "Ten dollars in the money." Consider it a $10 off coupon for ABC stock. One strategy for Jill would be to then exercise her right to buy ABC for $110, and simultaneously sell stock in the marketplace for $120. This would effectively net Jill a $10 profit per share of stock and option that she traded. (Actually, any option you buy on an exchange has a "100 multiplier". It is good for 100 shares of stock -- so an option that finished in-the-money by $10 would allow you to make $10 on 100 shares of stock, or $1000, not just $10)

Jack (the seller of the option), on the other hand would have the OBLIGATION to sell Jill ABC stock at the price of $110 dollars, $10 LESS than he could sell it in the marketplace. This represents, in terms of opportunity cost, a $10 loss to Jack.

This potential risk that Jack assumes when selling the option to Jill

the option. The buyer is purchasing the right to buy or sell stock at the predetermined price within the timeframe specified in the contract. The seller is giving the buyer the right to buy stock from the seller, or sell stock to the seller at the specified price. Should the buyer CHOOSE to exercise his right, it is the OBLIGATION of the option seller to fulfill that request. The buyer has no obligations to the seller.

So in each contract, the buyer has the OPTION to exercise, and the seller has the OBLIGATION to fulfill the request, if the buyer chooses to exercise.

Example: Jack Sells ABC 100 Call to Jill

Consider the case of stock ABC, trading at $100. Jack sells a $110 call (the right to buy stock for the price of $110) to Jill. Jill now has the right to purchase ABC stock from Jack, for the price of $110. Jill, obviously would not choose to exercise this right today, as she could easily buy ABC stock from the marketplace for $100, instead. However, if tomorrow, the price of ABC shoots up to $120, Jill may choose to exercise her RIGHT to buy ABC for $110. Doing so, Jill would be effectively buying ABC stock at a $10 discount to the market. We would say that ABC is "Ten dollars in the money." Consider it a $10 off coupon for ABC stock. One strategy for Jill would be to then exercise her right to buy ABC for $110, and simultaneously sell stock in the marketplace for $120. This would effectively net Jill a $10 profit per share of stock and option that she traded. (Actually, any option you buy on an exchange has a "100 multiplier". It is good for 100 shares of stock -- so an option that finished in-the-money by $10 would allow you to make $10 on 100 shares of stock, or $1000, not just $10)

Jack (the seller of the option), on the other hand would have the OBLIGATION to sell Jill ABC stock at the price of $110 dollars, $10 LESS than he could sell it in the marketplace. This represents, in terms of opportunity cost, a $10 loss to Jack.

This potential risk that Jack assumes when selling the option to Jill

N to fulfill the request, if the buyer chooses to exercise.

Example: Jack Sells ABC 100 Call to Jill

Consider the case of stock ABC, trading at $100. Jack sells a $110 call (the right to buy stock for the price of $110) to Jill. Jill now has the right to purchase ABC stock from Jack, for the price of $110. Jill, obviously would not choose to exercise this right today, as she could easily buy ABC stock from the marketplace for $100, instead. However, if tomorrow, the price of ABC shoots up to $120, Jill may choose to exercise her RIGHT to buy ABC for $110. Doing so, Jill would be effectively buying ABC stock at a $10 discount to the market. We would say that ABC is "Ten dollars in the money." Consider it a $10 off coupon for ABC stock. One strategy for Jill would be to then exercise her right to buy ABC for $110, and simultaneously sell stock in the marketplace for $120. This would effectively net Jill a $10 profit per share of stock and option that she traded. (Actually, any option you buy on an exchange has a "100 multiplier". It is good for 100 shares of stock -- so an option that finished in-the-money by $10 would allow you to make $10 on 100 shares of stock, or $1000, not just $10)

Jack (the seller of the option), on the other hand would have the OBLIGATION to sell Jill ABC stock at the price of $110 dollars, $10 LESS than he could sell it in the marketplace. This represents, in terms of opportunity cost, a $10 loss to Jack.

This potential risk that Jack assumes when selling the option to Jill

, Jill may choose to exercise her RIGHT to buy ABC for $110. Doing so, Jill would be effectively buying ABC stock at a $10 discount to the market. We would say that ABC is "Ten dollars in the money." Consider it a $10 off coupon for ABC stock. One strategy for Jill would be to then exercise her right to buy ABC for $110, and simultaneously sell stock in the marketplace for $120. This would effectively net Jill a $10 profit per share of stock and option that she traded. (Actually, any option you buy on an exchange has a "100 multiplier". It is good for 100 shares of stock -- so an option that finished in-the-money by $10 would allow you to make $10 on 100 shares of stock, or $1000, not just $10)

Jack (the seller of the option), on the other hand would have the OBLIGATION to sell Jill ABC stock at the price of $110 dollars, $10 LESS than he could sell it in the marketplace. This represents, in terms of opportunity cost, a $10 loss to Jack.

This potential risk that Jack assumes when selling the option to Jill

has a "100 multiplier". It is good for 100 shares of stock -- so an option that finished in-the-money by $10 would allow you to make $10 on 100 shares of stock, or $1000, not just $10)

Jack (the seller of the option), on the other hand would have the OBLIGATION to sell Jill ABC stock at the price of $110 dollars, $10 LESS than he could sell it in the marketplace. This represents, in terms of opportunity cost, a $10 loss to Jack.

This potential risk that Jack assumes when selling the option to Jill is the reason why Jill must pay Jack for the option. If the price of ABC stock were to go down to $90 and stay there past the predetermined expiration date of the option, Jack would pocket the amount of money that he sold the option for. This amount is the "premium" of the option.

Summary: When option sellers sell options, they assume a risk that they will be required to fulfill the obligation of the contract at a loss. For this risk, they receive the premium (price) of the option from the buyer.

When option buyers buy options, they acquire the potential to make money if the underlying stock moves in the direction they predict. If it does so, they stand to potentially gain the difference between the exercise price and the stock value at a later date. For this potential reward, they must pay the seller of the option the premium (price). If the option expires worthless, the buyer will have lost the premium.

Time Value

Would you pay more money for the option to buy MSFT for 25 dollars any time in the next 24 hours, or anytime in the next 10 years? 10 years, of course, because there is a greater likelihood that MSFT will trade at a MUCH higher price in the next 10 years, than in the next 24 hours. Increasing the duration of the contract (the time to expiration) increases the value of an option. Similarly, the right to sell MSFT at $15 by tomorrow is worth less than the right to sell MSFT at $15 within the next 10 years because there is a greater likelihood that MSFT will trade at a price less than $15 in the next 10 years.

From the perspective of the seller, there is a greater RISK that long term options will finish in-the-money. This greater risk requires them to demand a greater reward, in the form of higher premium.

For the buyer then, there is an inherent tradeoff between price and reward potential. If Jill had an inclination that ABC stock will decrease in value, she may choose to buy a put. As the value of ABC plummets, she would be able to sell ABC at a price higher than market value, while sim