⏱ 1-Minute Summary An option is a contract that gives the buyer the right, but not the obligation, to buy or sell 100 shares of a stock at a fixed price before a set date. The buyer pays a premium; the seller collects it and takes on the obligation. This article builds the vocabulary you need (calls vs puts, strike price, expiry, buyers vs sellers, ITM/ATM/OTM) from a zero-knowledge starting point, with a worked AAPL example.
0. Investing Basics: Stocks, Diversification, and Risk
Before options, you need three investing building blocks.
- A stock represents a tiny slice of ownership in a company. When you buy 1 share of AAPL, you own a fractional claim on Apple's future profits. Stocks can rise or fall in value; there is no guarantee.
- Diversification means spreading your money across many companies and asset classes instead of betting everything on one. It reduces the damage any single failure can cause.
- Risk is the possibility of losing money. Every investment carries risk. Options are a tool for expressing a view on direction, time, and volatility, and they can be riskier than simply buying a stock.
Options do not replace these basics; they build on top of them. If you are new to investing, understand stocks and diversification first.
1. Calls, Puts, Premium, and Long vs Short
There are two basic types of options.
- Call option: gives the buyer the right to buy 100 shares of the underlying at a fixed price. You buy a call when you expect the stock to rise.
- Put option: gives the buyer the right to sell 100 shares at a fixed price. You buy a put when you expect the stock to fall (or to protect a position you already own).
Premium is the price you pay to buy an option (or collect to sell one). Most standard equity options contracts represent 100 shares of the underlying stock, so a $2.00 premium = $200 per contract. Premium is composed of intrinsic value plus time value; you will see this in detail in the pricing article.
Options vocabulary uses long and short to describe whether you bought or sold the contract.
- Long an option = you bought it. You are the buyer (holder): you paid the premium and hold a right. (In stocks, "long" already means you own something hoping it rises; in options it means you hold the bought contract.)
- Short an option = you sold it. You are the seller (writer): you collected the premium and take on an obligation. (This is not the same as shorting a stock, where you borrow shares betting they fall: in options, "short" simply means "sold".)
Combine long/short with call/put to name any single-leg position:
| Position | What you did | What you hold |
|---|---|---|
| Long call | Bought a call | The right to buy the stock |
| Short call | Sold a call | The obligation to sell the stock (if assigned) |
| Long put | Bought a put | The right to sell the stock |
| Short put | Sold a put | The obligation to buy the stock (if assigned) |
These four positions are the single-leg building blocks the simulator backtests: Long/Short Call, Long/Short Put, and Cash-Secured Put.
2. Strike Price and Expiry
Two numbers define an option contract.
- Strike price (exercise price): the fixed price at which you can buy (call) or sell (put) the stock.
- Expiry date (expiration): the last day the option can be used. After expiry, the option ceases to exist.
These two fields appear in every option chain, e.g. "AAPL Dec $180 Call": the underlying is AAPL, expiry is December, strike is $180, and it is a call.
3. Buyer Rights vs Seller Obligations
The two sides of an options trade are not symmetric.
| Buyer | Seller (writer) | |
|---|---|---|
| Pays / receives | Pays premium | Receives premium |
| Has | A right (to exercise) | An obligation (to be assigned) |
| Maximum loss | Premium paid | Theoretically unlimited (Short Call) |
| Maximum gain | Theoretically unlimited (Long Call) | Limited to the premium |
Because the seller takes on an obligation, selling options requires margin or cash backing. Assignment risk (being forced to buy or sell the stock at the strike) is the seller's core risk, and it is explained in detail in the expiration article.
4. Premium: Intrinsic and Time Value
The premium is the price of the right: it splits into intrinsic value (what the option is worth if exercised today) and time value (what you pay for future movement).
The chart above shows this decomposition across stock prices: the buyer pays it, the seller collects it. It assumes a strike price of $200, 45 days to expiry, and a fixed implied volatility (IV) of 25%. When the underlying price is exactly $200 (ATM), the option has no intrinsic value but the most time value; market uncertainty is greatest when the price sits right at the strike.
As the price moves away from $200, the two curves diverge:
- Falls to $160: a long call has no intrinsic value and essentially no time value (the outcome is nearly certain: it will expire worthless). A long put is the opposite: only intrinsic value, because it is deep in the money and the outcome is nearly certain.
- Falls to $190: the long call still has no intrinsic value but keeps meaningful time value; the long put gains a little intrinsic value plus time value.
- Rises to $205: the long call picks up intrinsic value plus time value; the long put now has no intrinsic value and is all time value.
- Rises to $230: the long call is deep in the money: almost all of the premium is intrinsic value, with almost no time value left; the long put has neither; it is nearly certain to expire worthless.
In short: intrinsic value measures what the option is worth today, while time value pays for the chance that the underlying price moves before expiry. The further the underlying price is from the strike, the less time value remains.
5. ITM / ATM / OTM: Is the Option "In the Money"?
An option's moneyness describes whether it has intrinsic value today.
- ITM (In The Money): a call is ITM when the stock price is above the strike price; a put is ITM when the stock price is below the strike price. ITM options have intrinsic value.
- ATM (At The Money): the stock price is roughly equal to the strike price. No intrinsic value, but the most time value and the most sensitive to movement.
- OTM (Out of The Money): a call is OTM when the stock price is below the strike price; a put is OTM when the stock price is above the strike price. No intrinsic value, cheaper premium, and they may expire worthless.
| Option | Stock price vs Strike price | Moneyness |
|---|---|---|
| Call | Stock price > Strike price | ITM |
| Call | Stock price ≈ Strike price | ATM |
| Call | Stock price < Strike price | OTM |
| Put | Stock price < Strike price | ITM |
| Put | Stock price ≈ Strike price | ATM |
| Put | Stock price > Strike price | OTM |
The chart above shows the expiry P&L of a long call and a long put. It assumes a strike price of $200, 45 days to expiry, and a fixed implied volatility (IV) of 25%.
For Long Call: When the underlying price is below $200, it is OTM. When the underlying price is above $200, it is ITM. A long call profits when the stock rises above the break-even (the strike plus the premium you paid). Between the strike and the break-even you're still net-negative. Your loss is capped at the premium paid.
For Long Put: When the underlying price is below $200, it is ITM. When the underlying price is above $200, it is OTM. A long put profits when the stock falls below the break-even (the strike minus the premium you paid). Between the break-even and the strike you're still net-negative. Your loss is capped at the premium paid.
6. Closing, Exercising, and Expiring Worthless
An options position ends in one of three ways.
- Close: buy back or sell your option on the market before expiry. This is how most positions are ended.
- Exercise: the buyer uses the right to buy (call) or sell (put) the stock at the strike. Exercise happens rarely for typical traders; most prefer to close.
- Expire worthless: if an option is OTM at expiry, it becomes worthless. The buyer loses the premium; the seller keeps it.
For long-term EOD backtesting, the distinction matters because the closing price at expiry decides the outcome.
7. A Worked Example with AAPL
Suppose AAPL trades at $150, and you buy 1 AAPL $160 Call for a premium of $2.00 ($200 per contract).
- If AAPL rises to $180 before expiry: your call is ITM by $20. You could exercise and buy 100 shares at $160, or simply close the call for roughly $20 × 100 = $2,000 (minus the $200 premium), a large gain.
- If AAPL stays at $150: the $160 call is OTM and likely expires worthless. You lose the $200 premium.
- If AAPL falls to $130: the call is deep OTM. It expires worthless. Your loss is capped at the $200 premium.
The key takeaway: buying an option caps your loss at the premium while keeping upside if the move happens, but the option must move in your direction and within the time you paid for.
8. Where This Fits on the Platform
This platform backtests T-1 end-of-day (EOD) closing data for multi-day to multi-month long-term options strategies. Single-leg option concepts (Long/Short Call, Long/Short Put, and Cash-Secured Put) are the foundation of the simulator's strategy library. This article gives you the vocabulary; the strategy articles build on it.
⚠️ Platform Data Boundary: This article teaches options mechanics; the platform provides T-1 EOD closing snapshots only. Concepts here (strike, expiry, assignment) apply to any market, but all backtests on this platform are daily-frequency and suited to days-to-months holding periods, not intraday, 0DTE, or earnings-event strategies.
⚠️ Research Use Only: This article is educational. Options trading involves substantial risk of loss, especially when selling options. Nothing here is a buy or sell signal. Use this platform's backtests as historical statistical reference only; past performance does not guarantee future results.