Calls and Puts Explained: The Building Blocks of Options Trading

What Are Calls and Puts?

Calls and puts explained start with a fundamental principle: they are contracts, not equities. When you buy a call or put, you're purchasing the right—not the obligation—to buy or sell an underlying asset (stock, ETF, index, commodity) at a specific price on or before a specific date. This distinction between right and obligation separates options from stocks, where ownership carries responsibilities.

An options contract represents 100 shares of the underlying asset. When the quote shows a call trading at $2.50, the actual cost to purchase one contract is $250 (100 shares × $2.50). This multiplier effect is why options offer leverage: small price movements in the underlying asset can create substantial percentage gains or losses in the option itself.

Call Options Defined

A call option is a contract that gives the buyer the right to purchase 100 shares of an underlying asset at a predetermined price (the strike price) before the expiration date. The seller of the call receives the premium (price paid) but assumes the obligation to deliver shares if the buyer exercises the option.

Consider a real example: On January 15, 2024, Microsoft (MSFT) traded at $380. A trader purchases a March 2024 call option with a $385 strike price for $3.50 per share ($350 total premium). If MSFT rises to $395 by mid-March, the option holder can exercise, buying 100 shares at $385 (the strike) and immediately selling them at market value ($395), capturing the $10 intrinsic value. After subtracting the $3.50 premium paid, the net profit is $6.50 per share, or $650 per contract—a 186% return on the $350 investment.

Call buyers are bullish on the underlying asset. Call sellers (those writing calls) are generally neutral to bearish or seeking to generate income on holdings.

Put Options Defined

A put option gives the buyer the right to sell 100 shares of an underlying asset at the strike price before expiration. The seller receives the premium but must purchase shares at the strike if the buyer exercises.

Using a real scenario: On January 15, 2024, Apple (AAPL) traded at $185. A trader purchases a February 2024 put with a $180 strike price for $1.25 per share ($125 total premium). If AAPL drops to $175, the put holder can exercise, selling 100 shares at $180 (the strike) when the market price is $175—capturing $5 intrinsic value per share. After subtracting the $1.25 premium paid, the net profit is $3.75 per share, or $375—a 300% return on the $125 investment.

Put buyers are bearish on the underlying asset or seeking protection against downside risk. Put sellers are bullish or seeking to generate income by collecting premiums.

How Call and Put Pricing Works

Option prices are not arbitrary. They reflect two distinct value components: intrinsic value and time value. Understanding this breakdown is crucial for recognizing when options are expensive or cheap and for timing entry and exit points.

Intrinsic Value vs. Time Value

Intrinsic value is the amount by which an option is in-the-money (ITM). For a call, it's the difference between the underlying price and the strike price (if positive). For a put, it's the difference between the strike price and the underlying price (if positive). Out-of-the-money (OTM) options have zero intrinsic value.

Time value is the premium above intrinsic value. It represents the probability that an OTM option will move into-the-money before expiration. Time value decays over time, accelerating sharply in the final two weeks before expiration.

Example: TSLA trades at $240 on a hypothetical date. A March 2024 call with a $240 strike (at-the-money) trades for $8.50. The intrinsic value is $0 (the option is not ITM). The entire $8.50 is time value—the market's assessment of the probability that TSLA will close above $240 by March expiration.

If the same strike call has only 3 days to expiration and TSLA remains at $240, that call might trade for only $0.30—nearly all the time value has decayed.

The Black-Scholes Model and Implied Volatility

Professional traders and market makers use the Black-Scholes model (or similar pricing models) to calculate theoretical option values. The model inputs are:

• Current stock price
• Strike price
• Days to expiration
• Risk-free interest rate
• Historical volatility (how much the stock has moved historically)
• Implied volatility (what the market expects volatility to be in the future)

Implied volatility (IV) is the most dynamic variable and the primary driver of option price changes when the underlying stock is relatively stable. IV is expressed as a percentage; higher IV means the market expects larger price swings, so options are more expensive.

Practical observation: After earnings announcements, IV typically contracts sharply because uncertainty is resolved. A trader who bought calls or puts before earnings (when IV was elevated) often sees the option value decline even if the directional thesis was correct—the position loses value due to IV crush.

Moneyness: In-The-Money, At-The-Money, and Out-Of-The-Money

The relationship between the current stock price and the strike price determines an option's moneyness, which directly influences its value and likelihood of exercise.

In-The-Money (ITM)

Calls are ITM when the underlying price is above the strike price. Example: NVDA at $875, with a $850 call—$25 of intrinsic value.

Puts are ITM when the underlying price is below the strike price. Example: SPY at $450, with a $460 put—$10 of intrinsic value.

ITM options have a high probability of exercise or assignment. Buyers holding ITM calls often exercise to capture intrinsic value, especially just before expiration.

At-The-Money (ATM)

Both calls and puts are ATM when the underlying price equals (or is very close to) the strike price. ATM options have zero intrinsic value but maximum time value, making them the most price-sensitive to changes in implied volatility.

Out-Of-The-Money (OTM)

Calls are OTM when the underlying price is below the strike price. Example: XOM at $102, with a $110 call—$0 intrinsic value.

Puts are OTM when the underlying price is above the strike price. Example: QQQ at $365, with a $350 put—$0 intrinsic value.

OTM options are cheaper and higher-leverage but expire worthless more frequently. A $110 XOM call when XOM trades at $102 requires an 8% move in 5 days to be ITM at expiration. OTM options are the preferred vehicle for speculative, directional bets.

Greeks: Measuring Option Risk and Sensitivity

The Greeks quantify how an option's price responds to different market variables. Traders use Greeks to size positions, hedge risks, and manage portfolio exposure across thousands of contracts. Ignoring Greeks is a primary reason retail traders lose money in options.

Delta: Directional Sensitivity

Delta measures how much an option's price changes when the underlying asset moves $1. It ranges from -1 to +1.

For calls: Delta ranges from 0 to +1. A call with a delta of 0.60 means the call price increases approximately $0.60 for every $1 the stock rises. Delta also represents the approximate probability the option will be ITM at expiration—a 0.60 delta call has roughly a 60% chance of expiring ITM.

For puts: Delta ranges from -1 to 0. A put with a delta of -0.40 means the put price increases approximately $0.40 for every $1 the stock falls. A -0.40 delta put has roughly a 40% chance of expiring ITM.

Practical application: A trader bullish on AMZN but wanting defined risk buys 5 call contracts (500 shares of delta exposure) with an average delta of 0.70. The position behaves similarly to owning 350 shares of AMZN (500 × 0.70) profit/loss when AMZN moves, but with much lower capital outlay.

Theta: Time Decay

Theta measures how much an option loses value each day due to time passing, assuming all other variables stay constant. It's expressed as the change per day.

For call and put buyers: Theta is negative. A long call with a theta of -0.08 loses approximately $0.08 per day just from the passage of time. This is why time is the enemy for option buyers—even if the directional thesis is correct, theta erosion can eliminate profits on longer holding periods.

For call and put sellers: Theta is positive. They benefit from time decay. A seller receives $0.08 per day per contract as time erodes, all else equal. This is why selling premium (covered calls, cash-secured puts, credit spreads) can be profitable even in sideways markets.

Theta accelerates sharply in the final 7 days before expiration. An option that loses $0.10 per day with 14 days to expiration might lose $0.40 per day with 2 days to expiration.

Vega: Volatility Sensitivity

Vega measures how much an option's price changes when implied volatility changes by 1 percentage point (expressed as 1 vega = $1 per 1% IV change).

Both calls and puts have positive vega. A call with a vega of 0.25 increases $0.25 in value for every 1 percentage point IV rises. This is why buying options before earnings (when IV is expected to spike) can be profitable even without a directional move.

Conversely, selling options before earnings and buying them back after the announcement (IV crush) can be profitable if the position is managed correctly.

Gamma: Delta Acceleration

Gamma measures how much delta changes when the underlying asset moves $1. It's the acceleration of price change.

Example: A call with a delta of 0.50 and gamma of 0.03 will have a delta of 0.53 after the stock rises $1. Gamma is highest for ATM options and lowest for deep ITM or OTM options. Gamma is positive for long options and negative for short options.

Traders use gamma to understand convexity risk. A short strangle (selling both an OTM call and OTM put) has negative gamma—if the stock makes a large move, the trader faces unlimited losses.

Exercise and Assignment: What Actually Happens

Understanding when and why options are exercised is essential because most retail traders never exercise their options—they close the position for profit or loss instead.

When Options Are Exercised

An option is exercised when the holder decides to use their right to buy (call) or sell (put) the underlying asset.

Call exercise: A trader holds a $100 call on SPY purchased for $2.50. SPY rises to $106. The call buyer can exercise, purchasing 100 shares at $100 (paying $10,000) and immediately selling them at market price ($10,600), pocketing the $600 gain (minus commissions). However, most retail traders instead sell the call in the open market for $6.50 (or more), realizing the profit without the cash outlay or settlement hassles.

Put exercise: A trader holds a $85 put on XLF purchased for $1.50. XLF falls to $80. The put buyer can exercise, selling 100 shares at $85 (even though market price is $80), capturing the $500 difference. Again, most traders close the position by selling the put in the market instead of executing the exercise.

Assignment and Early Exercise

Assignment occurs when the holder of a short option (seller) is forced to complete the contract terms. If you sold a $100 call on SPY and the buyer exercises, you are assigned 100 shares at $100—cash leaves your account (or shares are deducted from your holdings).

Early exercise (before expiration) is uncommon for calls on non-dividend-paying stocks but common for puts and for calls on dividend-paying stocks just before the ex-dividend date. The reason: exercising a call just before dividends allows the call buyer to capture the dividend payment.

Risk awareness: If you sell calls on a stock and earn premiums, but that stock then rises sharply, you may face assignment at the worst possible moment, forcing you to sell shares below market value or close the position at a loss.

Practical Examples: Calls and Puts in Action

Example 1: Using a Call to Speculate on Upside

Date: January 10, 2024. Tesla (TSLA) trading at $240.

A trader is bullish on TSLA but only wants to risk $500. Instead of buying 2 shares ($480), the trader buys 5 call contracts with a $245 strike price expiring in 45 days for $1.80 per share ($900 total).

Scenario 1 (Bullish thesis correct): TSLA rises to $265 by mid-February. The call (originally purchased for $1.80) is now worth at least $20 ($265 strike - $245 intrinsic value), and likely more due to time value. Selling the position at $21 per share yields $10,500—a 1,067% return on the $900 investment. Compare this to 10.4% gain on owning 2 shares directly.

Scenario 2 (Bearish thesis): TSLA falls to $235 by expiration. The $245 call expires worthless. The trader loses the entire $900 premium paid—100% loss on the investment. However, they risked a defined amount (the premium), not unlimited downside.

Example 2: Using a Put to Hedge Downside

Date: October 3, 2023. You own 200 shares of Nvidia (NVDA) purchased at $380, currently trading at $415. You're concerned about a near-term pullback but confident in the long-term thesis.

Instead of selling shares, you buy 2 put contracts with a $400 strike price expiring in 60 days for $3.50 per share ($700 total).

Scenario 1 (No decline): NVDA remains at $415 or higher. The puts expire worthless, and you've paid $700 for downside insurance—similar to insurance premiums on a home. Your 200 shares are still worth $83,000. Net cost of hedging: $700 (0.84% of position).

Scenario 2 (Significant decline): NVDA drops to $360 by expiration. Without the put, your 200 shares would be worth $72,000 (a $8,300 loss). With the puts, you can exercise, selling 200 shares at $400 per share ($80,000), locking in that price. After subtracting the $700 put premium, your effective sale price is $396.50. You've capped losses at approximately $3,700 instead of $8,300.

Common Mistakes and Pitfalls to Avoid

Mistake 1: Buying Options Without Understanding Probability

Retail traders frequently buy deep OTM options (cheap premium) expecting home-run returns. A $2 call on a $100 stock requires a 50%+ move just to reach breakeven. These options expire worthless approximately 80-90% of the time.

Better practice: Buy options where you have a reasonable probability of profit. A delta of 0.40-0.60 (40-60% probability ITM) is more suitable for directional trades than buying 0.05 delta lottery tickets.

Mistake 2: Holding Through Expiration

Most retail traders hold options until the expiration date, maximizing time decay exposure. If a trade is winning, close it at 50-75% of max profit and redeploy capital. If losing, close it when you reach your stop-loss level instead of hoping for a last-minute reversal.

Better practice: Sell winners early and often. Close losing trades quickly. Most professional options traders close 90% of positions before expiration.

Mistake 3: Ignoring Implied Volatility Context

Buying options when IV percentile is already elevated (80th percentile or higher) means you're paying peak prices. A $200 call on SPY might be worth $3.50 when IV is at the 10th percentile but $2.20 when IV is at the 90th percentile—same stock price.

Better practice: Check IV percentile before buying options. Buy when IV is in the 20-40th percentile range. Sell premium when IV is elevated (70th percentile or higher).

Mistake 4: Over-Leveraging Position Size

Options offer leverage, but leverage cuts both ways. A trader with a $10,000 account who controls $100,000 in notional stock value (through options) can lose their entire account on a 10% adverse move.

Better practice: Risk only 1-2% of your account per trade, even with options. A $10,000 account should risk maximum $100-200 per options trade. This forces position sizing discipline and psychological resilience.

Mistake 5: Selling Naked Calls or Puts Without Hedges

Naked (unhedged) short calls have theoretically unlimited loss potential. A trader selling $200 calls on TSLA naked can face losses exceeding their account value if the stock gaps up.

Better practice: Until you understand portfolio Greeks and margin requirements, only sell covered calls (against shares you own) or cash-secured puts (with cash set aside to buy shares). These have defined maximum losses.

Calls and Puts vs. Other Strategies

Calls and puts are the foundational building blocks for more complex strategies. Understanding these basics is prerequisite for learning spreads, straddles, and other multi-leg positions.

• Long Call + Long Put (Straddle): Bet on volatility regardless of direction. Profitable if the stock makes a large move in either direction.
• Call Spread (Bull Call Spread): Buy a call, sell a higher-strike call. Reduces cost, caps profit. Lower risk/reward profile.
• Put Spread (Bear Put Spread): Sell a put, buy a lower-strike put. Collects defined premium, defined maximum loss.
• Iron Condor: Sells both call and put spreads on the same underlying. Profits if stock stays between two price levels.

All these strategies are combinations of calls and puts. Master the fundamentals of individual calls and puts before layering complexity.

Risk Disclaimers

Options trading involves substantial risk of loss. This article is educational and does not constitute investment advice. Specific risks include:

• Total loss of premium paid for long options
• Assignment risk and forced share purchase/sale for short options
• Margin calls and forced liquidation if using leverage
• Liquidity risk—inability to close positions in wide bid-ask spreads
• Overnight gaps causing disproportionate losses on short positions
• Model risk—options pricing models are approximations, not certainties

Start with small position sizes, paper trade first, and consider working with a financial advisor before deploying significant capital.

Frequently Asked Questions

Q: Can I lose more money than I invested in a long call or put?

No. The maximum loss on a long call or long put is the premium paid upfront. If you buy a call for $300 and it expires worthless, you lose $300—not more. This defined risk makes long options attractive for defined-risk speculators.

Q: What's the difference between American and European options?

American options can be exercised any time up to expiration. European options can only be exercised on the expiration date. Most U.S. stock options are American. European options are more common in index options (SPX) and foreign exchanges. For practical purposes, American options are slightly more valuable due to early exercise flexibility.

Q: Do I need 100 shares to exercise a call I've purchased?

No. Most brokers allow cash settlement. If you exercise a call, you can immediately sell the resulting shares (if you don't want to hold them) and keep the profit. The broker handles the mechanics.

Q: Why did my profitable option lose value even though the stock moved in my favor?

Time decay and implied volatility changes. If you bought a call and the stock rises 2% but implied volatility falls 15%, the net effect can be negative theta and vega outweighs positive delta. Always monitor all Greeks, not just the price direction.

Q: Can I sell options I don't own?

Yes, but only with a margin/options-approved brokerage account. Selling a call you don't own is called "selling a naked call." It's risky because your potential loss is unlimited if the stock rises sharply. Most brokers restrict naked short calls to experienced traders.

Q: What expiration date should I choose for my options?

General guidelines: For directional trades, choose 30-60 days to expiration (balances time decay and probability). For hedges, choose 60-90 days. Avoid weeklies unless you're an active trader—theta decay accelerates sharply on 2-3 day expirations.

Next Steps in Your Options Education

You now understand the foundational mechanics of calls and puts, pricing components, the Greeks, and common pitfalls. Your next steps are:

1. Practice with paper trading: Open a demo account and simulate 20-30 trades using only calls and puts before deploying real capital.
2. Learn spreads: Read our guide on bull call spreads and bear put spreads to reduce cost and define maximum losses.
3. Study implied volatility: Track IV percentile on stocks you follow and understand how to profit from mean reversion in volatility.
4. Read our complete Options Trading hub: Access our full How to Trade Options guide at /learn/options for strategies, tax considerations, and advanced techniques.

Calls and puts are the alphabet of options—once you're fluent, all other strategies follow logically. Spend adequate time with these fundamentals before advancing to more complex positions.