Calls and puts — the two types
A call option gives the holder the right to buy the underlying asset at the strike price before expiry. You buy a call if you expect the price to rise: if you buy a call option to purchase Apple shares at £150, and Apple rises to £180, you can exercise the option and immediately profit from the £30 difference (less the premium you paid for the option). A put option gives the holder the right to sell at the strike price. You buy a put if you expect the price to fall, or to protect against a fall in something you already own.
The premium and what drives it
The option premium (the price you pay) has two components. Intrinsic value: how much the option is already "in the money" — a call with strike £100 on a stock trading at £110 has £10 of intrinsic value. Time value: the additional amount the market pays for the chance that the option will move further in the money before expiry. Time value erodes as expiry approaches (a phenomenon called "theta decay"). Volatility is the other key driver: the higher the expected volatility of the underlying, the more valuable an option — you need bigger moves to profit, but the upside is larger.
Who uses options and for what
Options are used in two broad ways. Hedging: an investor who owns 10,000 shares in a company but worries about a short-term fall can buy put options to protect against the downside — effectively buying insurance on the portfolio. This is how institutional investors use options most often. Speculation: an options buyer gets leveraged exposure. If Apple shares rise 10%, a call option might rise 100%. This leverage cuts both ways — options can expire worthless if the underlying doesn’t move enough, losing 100% of the premium paid.
“Options are a legitimate tool used by sophisticated investors for risk management. They are also the instrument through which many retail investors have lost their savings. The difference is understanding.”
What this means for you
As a beginner, the most useful thing to understand about options is their payoff asymmetry: the buyer’s maximum loss is capped at the premium, but the seller’s potential loss can be unlimited (for naked calls) or very large (for cash-secured puts). Most retail losses in options come from selling without understanding this. If you want to learn options in practice, start with covered calls (selling calls on shares you already own — capping your upside but generating income) or cash-secured puts (selling puts on shares you’d be happy to own at a lower price). These strategies limit downside in ways naked speculation does not.