Stock options — what they are and how they work

Quick Answer

An option is a derivative instrument that gives the buyer the right (but not the obligation) to buy or sell an underlying asset at a fixed strike price within a set time, in exchange for paying an option premium. A call gives the right to buy (used when you expect a rise); a put gives the right to sell (used to bet on declines or hedge). An option buyer can only lose the premium paid, while a seller of an uncovered option faces potentially unlimited losses. Options carry leverage and time decay. This is educational information, not investment advice.

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What is an option?

An option is a derivative instrument that gives the buyer the right (but not obligation) to buy or sell an underlying asset at a fixed price within a specified time.

For this right, the buyer pays an option premium — the price of the option.

Types of options

Call option

Gives the right to buy an asset at a fixed price (strike price). You buy a call when you expect price to rise.

Example: You buy a call option on company X shares with strike price 100 PLN for a premium of 5 PLN. If the price rises to 120 PLN — you earn 15 PLN (120 − 100 − 5). If it falls — you only lose the premium (5 PLN).

Put option

Gives the right to sell an asset at a fixed price. You buy a put when you expect a decline or want to hedge your portfolio.

Key concepts

• Strike price — the price at which you can buy/sell the asset
• Premium — the price you pay for the option
• Expiration date — the date until which the option is valid
• In the money (ITM) — option has intrinsic value (profitable to exercise)
• Out of the money (OTM) — option has no intrinsic value
• At the money (ATM) — asset price ≈ strike price

Profit and loss profile

Conclusion: option buyers risk only the premium. Option sellers take on potentially unlimited risk.

What are options used for?

1. Speculation — profiting from price movements with limited risk (buying options)
2. Hedging — protecting stock portfolio with put options
3. Income generation — selling call options on owned stocks (covered call)
4. Complex strategies — spread, straddle, strangle — combinations of options with different parameters

Options on WSE

Options on the WIG20 index are available on WSE. The market is smaller and less liquid than on American exchanges, but enables basic option strategies.

Options vs futures

Key difference: option gives a right, futures gives an obligation. Option buyer cannot lose more than the premium. In futures, loss is theoretically unlimited.

How can Freenance help

Freenance allows you to include options in your investment portfolio and track their impact on overall portfolio exposure and risk.

👉 Monitor your entire portfolio in one place — freenance.io

FAQ

What is the difference between a call and a put option?

A call option gives the buyer the right to buy the underlying asset at the strike price, used when the buyer expects the price to rise. A put option gives the right to sell at the strike price and is typically used to bet on declines or to hedge an existing long position.

What is the option premium and how is it determined?

The premium is the price the buyer pays the seller for the option contract. It depends on the asset's current price relative to strike, time to expiration, expected volatility, interest rates, and dividends, with longer-dated and more volatile options carrying higher premiums.

What does the strike price mean?

The strike price (also called the exercise price) is the level at which the option holder can buy (call) or sell (put) the underlying asset. Whether the option ends up in, at, or out of the money depends on how the market price compares to this strike at expiration.

How much can I lose on an option?

A buyer of an option can only lose the premium paid, no matter how the underlying moves. A seller of an uncovered (naked) option, especially a naked call, can in theory face very large or unlimited losses, which is why option writing is treated as an advanced strategy.

Are options suitable for beginner investors?

Options are derivatives with leverage and time decay, and they require understanding of how premium, volatility and expiration interact. Beginners usually focus on equities, ETFs and bonds first, and only introduce options once they can clearly define the risk and reward of each position before opening it.