Option
The right, not the obligation, to buy (call) or sell (put) an asset at a set price.
A right, not an obligation
A call option gives the right to buy an asset at a set price, the strike, until a given date. A put gives the right to sell. The buyer pays a premium; the maximum loss is that premium. The seller pockets the premium but takes a risk that can be unlimited.
What drives an option’s price
The underlying price, the strike, the time left, rates and above all expected volatility. The more movement the market expects, the dearer the option: that is how the VIX is derived from S&P 500 option prices. The Black-Scholes model (1973) provided the first benchmark formula.
Formula
Gain d’un call à l’échéance = max(0, cours - prix d’exercice) - prime
- Put: max(0, strike - price) - premium
Worked example
A 100-strike call bought for 5
- You pay €5 for the right to buy at €100 in three months.
- At expiry the stock is at €120: gain of 120 - 100 - 5 = €15.
- If it is at €90 you do not exercise: loss limited to the €5 premium.
Break-even at €105; +€15 is +300% on the premium.
Common mistakes
- Forgetting that time value melts every day: an option can lose even if the price does not move.
- Selling naked options: the loss can far exceed the premium received.
Notitia newsroom · education, not investment advice.