An option is a derivative contract that gives its holder the right, but not the obligation, to buy or sell an asset at a specified strike price before an expiration date. The buyer pays a premium; if the conditions are unfavorable, the option can expire and the premium is generally the defined loss. A programmer’s analogy is an API key for buy() or sell(): pay for access, execute only when conditions justify it. section 1.2.7
Distinguish the main positions and their risk profiles:
- Buy a call to obtain the right to buy at the strike price, typically expressing a view that the asset may rise. section 1.2.7
- Buy a put to obtain the right to sell at the strike price; holding one against stock can provide protection against price drops. section 1.2.7 section 7.4.1
- Write an option to receive the premium while accepting an obligation: a written put can require buying the stock at the strike price even after a severe decline. section 1.2.7
Hedging an earnings call
Pedro owns ACME stock bought at $100 per share and expects uncertainty around an earnings call. He buys a put with a $95 strike. If ACME remains above $95, the premium functions like insurance that was not needed; if ACME falls below $95, the put allows him to sell at $95 and limit the loss. section 7.4.1
Options can provide leverage with lower upfront costs than shares, and buyers know the premium committed. They can also target increased volatility without requiring an exact directional prediction. Those advantages do not make outcomes predictable: leveraged or short-option positions can produce severe losses, and trading options around volatile earnings can resemble gambling. section 11.2.3 section 1.2.7
