What Are Options and How Can Investors Use Them?
Options are useful for investors who want to bet on directional price moves, generate income and manage their risk.


Options are part of an asset class known as "derivatives," which means they perform based on the movement of an underlying asset.
For purposes of our discussion, we'll focus on equity, index and exchange-traded fund (ETF) options, which are among the most actively traded of these vehicles.
Formally, options are contracts between two parties that give buyers the right but not the obligation to purchase or sell a predetermined number of shares of an underlying asset at a specific price on or before a specific expiration date.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
What are options?
Generally speaking, investors who expect the underlying asset to rise would buy a call option, which gains value as the associated shares increase in value.
Call options allow the holder to buy shares of the underlying asset at the price stated on the contract (the "strike price") on or before the contract's expiration date, provided the stock trades above that price.
Investors who expect a stock to decline would buy a put option, which gains value as the underlying share price falls.
Holders of put options enjoy the right to sell shares at a contract's strike price on or before its expiration date, so long as the price of the underlying stock declines.
How are options priced?
Most standard options contracts are based on 100 shares of an underlying stock, which is crucial to know. Options prices are quoted on a per-share basis, so a call option quoted at 75 cents will actually cost $75 to buy (75 cents per share multiplied by 100 shares per contract).
Occasionally, corporate events such as acquisitions, mergers, divestments, stock splits and other scenarios can result in adjustments to options contracts based on the underlying equity.
Depending upon the nature of the adjustment, the underlying asset and/or the strike price may be changed to reflect the new value of the options contracts. Nonstandard options will be indicated by an updated symbol within the stock's options chains.
How do options work?
The purchase or sale price fixed in an options contract is called the "strike price." Strike prices vary based on the price, trading range, share volume and popularity among options traders of the underlying stock.
Options strike prices may be listed as tight as 50 cents or as wide as $5 to $10 depending on liquidity and demand for specific contracts.
Similarly, a more heavily traded and liquid stock will have a wider variety of expiration dates to consider.
While a less actively traded stock may have only a few monthly options expiration dates listed at one time, the most popular stocks and ETFs will have weekly or even daily options expiration series available to trade.
There are a few potential outcomes for the buyer of the options contract. The options contract can be sold to close – for a profit or a loss – at any time prior to expiration. This closing transaction, once filled, ends the trade and any related terms of the options contract.
Alternatively, the buyer might choose to exercise an in-the-money option.
A call is "in the money" when the price of the underlying stock is above the strike price of the options contract. A put is in the money when the price of the underlying stock is below the strike price of the options contract.
An in-the-money call or an in-the-money put can be exercised at any time up to expiration under the terms of the options contract.
The call option holder has the right to buy 100 shares of the underlying stock at the strike price, and the put option holder has the right to sell 100 shares of the underlying stock at the strike price.
Many options contracts are never exercised and are either closed out prior to expiration or simply left to expire worthless. But brokerages may automatically exercise in-the-money options at expiration, so it's important for investors to actively manage their puts and calls.
How do investors use options?
Investors can use call options and put options to speculate on directional moves for the price of the underlying stock.
And both types of options can be sold against existing stock or cash positions to generate income or to acquire additional shares at favorable prices.
Options can also be used to hedge equity or ETF holdings and manage risk within a broader portfolio. Options strategies that rise in value when the value of underlying assets fall can help mitigate potential losses.
Related content
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Elizabeth Volk has been writing about the stock and options markets since 2007. Her analysis has been featured on CNBC, published in Forbes and SFO Magazine, syndicated to Yahoo Finance and MSN, and quoted in Barron's, The Wall Street Journal, and USA Today.
-
Did Florida’s Chance at $1,000 in Property Tax Rebates Vanish?
State Taxes The Florida Legislature bypassed Gov. Ron DeSantis’ wish to cut property taxes and instead voted to lower the state’s sales tax.
By Gabriella Cruz-Martínez Published
-
Wall Street Is Worried About Apple Stock. Should You Be Too?
Analysts expect Trump's sweeping tariffs to have an outsized impact on Apple stock. How concerned should investors be?
By Karee Venema Published
-
Wall Street Is Worried About Apple Stock. Should You Be Too?
Analysts expect Trump's sweeping tariffs to have an outsized impact on Apple stock. How concerned should investors be?
By Karee Venema Published
-
The Stock Market Is Selling Off. Here's What Investors Should Do
Investors are fleeing the equities market en masse in response to the Trump administration's "jaw-dropping" tariffs. But the experts say don't panic.
By Karee Venema Last updated
-
How Building Liquidity Into Your Retirement Plan Can Pay Off
To succeed in investing for retirement, you need time and discipline — liquidity can give you both.
By Samantha Compton, IAR Published
-
Striking Oil in Opportunity Zones: Now Might Be the Best Time to Invest
You could unlock hidden wealth in QOZs with strategic oil and gas investments, potentially combining tax advantages with long-term growth in an essential industry.
By Daniel Goodwin Published
-
Stock Market Today: It's the Old Up-Down Again on Liberation Day
Markets look forward to what comes with the reordering of 80-year-old global trade relationships.
By David Dittman Published
-
Can a New Manager Cure Vanguard Health Care Fund?
Vanguard Health Care Fund has assets of $40.5 billion but has been ailing in recent years. With a new manager in charge, what's the prognosis?
By Nellie S. Huang Published
-
What You Don't Know About Annuities Can Hurt You
Lack of awareness leads many to overlook these potent financial tools, and with the possibility of running out of money in retirement, that could really hurt.
By Ken Nuss Published
-
Three Keys to Logical Investing When Markets Are Volatile
Focusing on these market fundamentals can help investors stay grounded rather than being swayed by emotion or market hysteria.
By Dennis D. Coughlin, CFP, AIF Published