Options: the rights vehicle

A right, not the thing

An option is a contract that gives its buyer a right. A call gives the right to buy a stock at a set price, by a set date. A put gives the right to sell at a set price, by a set date. Buy one and the right is yours; the obligation belongs to whoever sold it, and they were paid to carry it. The seller, in exchange for the premium, accepts an obligation they cannot walk away from — if the right is exercised, they must perform, at the agreed price, on the agreed date. Notice what you do not hold: no shares, no votes, no dividends — Lesson 13's ownership is absent here, replaced by a right that exists only because a date and a price are written on it. Two contract terms are assumed throughout this lesson: one option contract covers 100 shares — the contract multiplier, so a premium quoted at $2.00 is $200 paid per contract — and every option has an expiration date, the day the right ends. For a reader with a job, the draw and the danger are the same fact: the ticket’s cost is fixed and known, but its clock runs on calendar time, indifferent to your schedule.

The premium is the whole ticket

The price of that right is the premium, and for a buyer it is the whole price of admission. Your cost is known the moment you pay it, and your loss is capped at it: the worst an option you bought can do is expire unused, and you are out the premium — never more. No bill follows, no settlement hunts you. The cap is structural, not a favor: the premium was the buyer's only obligation, so there is nothing left for anyone to collect. That makes this the only leveraged vehicle in this folder whose worst case is printed on the ticket before you buy it. Read that sentence again before the next section, because the leverage it describes is real, and it is not free.

The cap has exactly one door in it: exercise. The premium is the buyer’s whole obligation only while the option stays an option. Exercise a call and you pay the strike — a $100 strike is $10,000 per contract, because one contract covers 100 shares — and wake up owning stock, with a stock’s open-ended downside, long after the premium’s tidy cap stopped applying. Exercise a put and you must deliver stock at the strike, which means owning it or borrowing it first. Most buyers sell the ticket rather than exercise it, and this is why: selling keeps the cap; exercising trades the cap for the underlying, at the underlying’s full price and risk.

Two dials: strike and date

Every option is defined by exactly two choices: the strike — the price at which the right applies — and the expiration date, the day the right ends. Everything else about the contract follows from those two dials and the premium the market charges for them. As a rule of thumb, a strike near today's price costs more than one far away — for a call, "far" means above today's price; for a put, below it — because a right already close to useful is worth more. But distance alone never sets the price: the time left and how jumpy the stock is matter too, so a far strike on a wild stock can cost more than a near strike on a calm one. More time, for the same strike, usually costs more as well — which is the next section's subject. Naming the dials is this lesson's job, and it stops there on purpose: choosing between strikes and dates is a different discipline, taught elsewhere, on other evidence. A long-dated option — this desk's LEAPS — is simply this same instrument with the date dial turned far out.

The clock is the rent

Part of what a premium buys is time — and time, in this vehicle, is a wasting asset. An option's time value decays as its date approaches: a right with three months left is worth more than the same right with three weeks left, even if the stock has not moved a cent. The decay is not a steady drip at a constant rate: it runs slowly while the date is far off and speeds up as expiration approaches — the final weeks spend time value far faster than the first weeks do. The decay runs on calendar time. Weekends count. Holidays count. The stock can do absolutely nothing and the option you hold still gets a little cheaper, because some of what you bought — time — has been spent. Standing still costs money here. That is not a flaw; it is the rent, stated plainly.

Leverage, rented by the day

Why accept rent like that? Because a small premium moves with a stock-sized position: a few hundred dollars of premium can rise and fall with a hundred shares' worth of price movement. That is leverage — the same multiplication Lesson 14 described, reached a different way. The honest other half is in this section's heading: the leverage is rented, not owned, and the meter runs daily. In the futures market you post a deposit and settle nightly; here you pay the premium once and the clock collects. Every vehicle in this folder charges for leverage. They just bill in different currencies.

Practice

Work this fictional example on paper. One call contract, strike $50, premium $2.00 a share — one contract covers 100 shares. (1) How much do you pay for the contract? (2) At expiration the stock is $54: what is the right worth, and what is your result before fees? (3) At expiration the stock is $49: what is the right worth, and what is your result? (4) Instead of selling the right at $54, you exercise it: how much cash does that take, and what do you hold afterward?

Work it through: (1) $2.00 × 100 = $200 — the premium is the whole ticket. (2) The right to buy at $50 what trades at $54 is worth $4 a share, $400 a contract; $400 − $200 = +$200 before fees. (3) Nothing — the right expires unused and the result is −$200, the premium and never more. (4) $50 × 100 = $5,000, and you wake up owning 100 shares — a stock position, with a stock’s open-ended downside; the premium’s tidy cap stopped applying at exercise.