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Options trading offers a flexible way to speculate, generate income or hedge risk in the stock market. Whether you’re a beginner curious about the basics or a seasoned trader looking to refine your strategy, understanding how contracts work — and how much they can cost — is essential before you place a trade.
Options trading has grown fast among everyday investors. The number of equity option contracts traded in the US rose from 4.9 billion in 2019 to 11 billion by 2023.(1) 2025 is on pace to be a sixth straight record year for US options volume.(2)
This guide covers what options are, how they’re priced, the levels and permissions brokers require, how to place and manage a trade and the fees to expect along the way.
Key takeaways
An option is a contract giving the right, but not the obligation, to buy or sell an asset at a set price by a certain date.
To buy options, you select a contract through your broker — choosing the underlying asset, expiration date and strike price — then place an order for a call or a put.
Brokers assign an options trading level based on your experience and finances, which determines which strategies you’re allowed to use.
Options trading fees can include a per-contract fee, exchange pass-through fees and, occasionally, assignment or exercise fees.
What is options trading?
Options are financial contracts that give you the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific timeframe.(3)
There are two main parties in every options trade: the option buyer (or holder) and the option seller (or writer). The buyer pays a premium for the right, but not the obligation, to buy or sell the underlying asset. The seller receives that premium as compensation for the risk they take on. Most notably, that risk includes the obligation to buy or sell the underlying security at the strike price if the buyer chooses to exercise.(4)
Options are derivatives, meaning their value comes from an underlying asset such as a stock, index or exchange-traded fund (ETF). They can be used for speculation, income generation or hedging. Holding an option doesn’t mean you own the underlying asset or that you’re entitled to its dividends.
How does options trading work?
Options trading revolves around contracts that give holders the right to buy or sell an asset at a set price on or before a specified expiration date.(5)
Types of options
There are two main types of options — call options and put options. Traders build strategies and combinations from these two building blocks to pursue different goals.
Call options A call option gives you the right to buy the underlying asset at a predetermined strike price within a certain period. If the asset’s market price rises above the strike price, you can exercise the right to buy at the lower strike price, then sell at the higher market price for a profit.
Think of a call option as a coupon that lets you buy an asset at a set price. If the asset’s price goes up, you use the coupon to buy it cheaper than the market rate. If it doesn’t go up, you simply let the coupon expire and lose only the small amount you paid for it.
In exchange for the buyer’s premium, the seller of a call agrees to sell the stock at the agreed strike price if the option is exercised.(4)
Call option example Say you buy a call option with a strike price of $50, and the stock rises to $60 before expiration. You can exercise the option to buy at $50, then sell at $60 for a $10-per-share profit. Alternatively, you can sell the option contract itself without ever exercising it, since its price rises the further it moves into the money.(6) A call option is in-the-money when its strike price is below the stock’s actual price.
Put options A put option gives the holder the right to sell the asset at the strike price within a certain period. If the market price falls below the strike price, the holder can sell at the higher strike price and profit from the difference, minus the premium paid. The seller receives a premium for taking on the obligation to buy the asset if the holder exercises. A put option can act like an insurance policy against a big drop in an asset’s value.
Put option example Say you own 100 shares and buy a put option with a strike price of $20. If the stock drops to $10 before expiration, you can exercise the option to sell your 100 shares at $20 each. If you don’t own the underlying stock, the contract itself has still gained value because the market price is below the strike price, so you can sell the option contract for a gain instead.
Key options terms
Strike price. The predetermined price at which the asset can be bought or sold.
Premium. The price paid for the option contract.
Expiration date. The date on which the option expires and can no longer be exercised.(5)
Exercise. Using the option to buy or sell the underlying asset.
At-the-money (ATM). The option’s strike price equals the underlying asset’s current market price.
In-the-money (ITM). A call is ITM if the strike price is below the asset’s market price. A put is ITM if the strike price is above the asset’s market price.(7)
Out-of-the-money (OTM). A call is OTM if its strike price is above the asset’s market price. A put is OTM if its strike price is below the asset’s market price.(7)
Intrinsic value. The real, measurable value an option would have if exercised immediately.
Options trading levels
Before you can trade options, your broker assigns you an approval level (sometimes called a tier) based on your trading experience, financial situation and risk tolerance. The exact number of levels and what each one unlocks varies by broker. Fidelity currently uses a 3-tier structure.(8) Other brokers use 4 or 5 levels. A common industry breakdown looks like this:
Level 1. The most basic level, allowing covered calls and protective puts — strategies backed by shares you already own, so the risk is relatively limited.(9)
Level 2. Includes Level 1, plus buying calls and puts outright. Risk is limited to the premium paid for the contract.
Level 3. Includes Levels 1 and 2, plus more advanced strategies like spreads and straddles involving multiple contracts, typically requiring a margin account.
Level 4. Includes Levels 1–3, plus uncovered (“naked”) options trading, where the seller doesn’t own the underlying asset. This carries the potential for unlimited losses if the market moves against the seller.
Level 5. Where offered, this is the most advanced tier, permitting uncovered writing of index options and straddles.
Buying calls. Profit from a rising asset price; you gain if the market price exceeds the strike price before expiration.
Buying puts. Profit from a falling asset price; you gain if the market value drops below the strike price before expiration.
Covered calls. If you already own the underlying asset, sell a call option against it for extra income — though this caps your upside if the option is exercised.
Protective puts. Buy a put on an asset you own to hedge against a price drop.(9)
Choose a broker and apply for options permission
You’ll need a brokerage account that supports options trading. Platforms like Charles Schwab, E*TRADE and Robinhood work well for both beginners and advanced traders.
Once your account is open, you’ll apply for options approval. Brokers assess your experience, finances and risk tolerance, then assign the trading level that determines which strategies you can use — from beginner strategies like covered calls up to spreads or uncovered options.
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Investing in alternative investments and/or strategies may not be suitable for all investors and involves unique risks, including the risk of loss. An investor should consider their individual circumstances and any investment information, such as a prospectus, prior to investing. Interval Funds are illiquid instruments, the ability to trade on your timeline may be restricted. Brokerage and Active investing products offered through SoFi Securities LLC, Member FINRA (www.finra.org) /SIPC(www.sipc.org).
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Research the underlying asset
Research the stock, ETF or index you’re considering. Fundamental analysis looks at earnings, revenue growth and industry trends. Most options traders lean more heavily on technical analysis, watching price patterns, volume and momentum indicators. Keep an eye on volatility, interest rates and geopolitical events, all of which can move option prices independent of the underlying stock.
Choose the right option contract
Once you’ve picked an asset, decide on:
Call or put. The right to buy or sell.
Strike price. Reflecting where you expect the asset’s price to move.
Expiration date. Matching your investment timeline and outlook.
Moneyness. Whether the contract is in-the-money, at-the-money or out-of-the-money relative to the asset’s current price.(7)
Place the trade
Navigate to your broker’s options section, select the contract, enter the number of contracts and confirm the order details, including the limit or market price. Review carefully before submitting. Once placed, you’ll see the open position along with its expiration date and current market value.
Monitor and manage the trade
Once you’re in a position, you generally have three choices as expiration approaches:
Sell the option before expiration to lock in profit or cut losses.
Exercise the option if it’s in-the-money.
Let it expire if it’s out-of-the-money — you lose the premium paid but take on no further obligation.
Review and refine your strategy
After closing a trade, review the timing of your entry and exit, the accuracy of your market read, and whether the strategy suited your goals. Tracking your trades over time helps you spot patterns and adapt as conditions change.
Options trading examples
Buying calls
Say XYZ stock trades at $50 and you expect it to rise. You buy a call option with a $55 strike price, expiring in one month, for a $2-per-share premium. Each contract covers 100 shares, so the trade costs $200 total.
If the stock rises to $60 before expiration, the option is in-the-money. You can exercise it to buy 100 shares at $55, then immediately sell at $60. That’s a $500 gain, minus the $200 premium, for a $300 net profit.
Buying puts
Say ABC stock trades at $70 and you expect it to fall. You buy a put option with a $65 strike price, expiring in two months, for a $3-per-share premium — $300 total for the 100-share contract.
If the stock falls to $60 before expiration, the option is in-the-money. You can exercise it to sell 100 shares at $65 despite the $60 market price. That’s a $500 gain, minus the $300 premium, for a $200 net profit.
How options are priced
Option prices are driven by a few core components, as reflected in the Black-Scholes model published in 1973:(10)
Intrinsic value. The difference between the underlying asset’s current price and the strike price. A call with $5 of intrinsic value means the stock is trading $5 above the strike price.
Time value. The time remaining until expiration. As expiration nears, time value decreases.(6)
Volatility. A measure of the underlying asset’s price swings. Higher volatility generally means higher premiums.(11)
Options trading fees to consider
Fees can meaningfully affect your returns, especially if you trade often or in size:
Commissions. Many brokers have eliminated per-trade commissions on basic options orders. It’s still worth checking your broker’s fee schedule directly.
Contract fees. Most major brokers charge a flat per-contract fee, commonly around $0.65, with some charging $1 or more.(12)
Pass-through fees. Brokers pass along exchange and clearinghouse charges, such as the Options Regulatory Fee (ORF). Rates vary by exchange and generally run well below a cent to a couple of cents per contract side.(13)
Assignment and exercise fees. Some brokers charge a fee if your option is exercised or assigned. The exact amount depends on your platform.
Advantages and risks of options trading
Advantages
Leverage. Options allow for amplified returns with a smaller upfront investment.
Flexibility. A broad range of strategies works in bullish, bearish or flat markets.
Income generation. Strategies like covered calls can generate income from assets you already hold, though no strategy is risk-free.
Hedging. Puts can offset losses elsewhere in a portfolio, acting as a form of insurance.
Limited downside for buyers. The most a buyer can lose is the premium paid.(14)
Risks
Total loss of premium. If an option expires out-of-the-money, the entire premium is lost. This makes options riskier than stocks, which typically retain some value in a downturn.
Complexity. Concepts like time decay and implied volatility take time to learn, and getting them wrong can hurt returns.
Unlimited risk for sellers. Selling uncovered calls can produce unlimited losses, since a stock’s price has no ceiling. Selling puts caps the maximum loss at the strike price, since a stock can’t fall below zero.
Volatility risk. Options are highly sensitive to swings in the underlying asset, which can quickly change a contract’s value in either direction.
Bottom line
Options trading offers real opportunities for profit, income and hedging, but it comes with real risk and a learning curve. Start with a level and strategy that matches your experience, size positions conservatively, and if you’re ready to get started, compare the best options trading platforms to find the tools and education that fit how you trade.
Frequently asked questions
Options generally follow regular market hours — weekdays from 9:30 a.m. to 4 p.m. ET for US exchanges. Some brokers offer extended hours, but liquidity is typically lower during those windows.
Not inherently. Traders who understand market movements, select strategies deliberately and manage risk are investing, not gambling. Trading options without a plan or risk controls can resemble gambling in practice, though.
Potential profit varies widely based on strategy, market conditions and capital invested. Options can offer outsized returns relative to buying stock outright, but they carry a correspondingly higher risk of loss, including total loss of the premium paid.
It depends on your goals, risk tolerance and market knowledge. Options offer flexibility and leverage that stocks don't, but with added complexity and risk.
It can be, if you start with simple, defined-risk strategies like covered calls or protective puts, learn the key terms first and use small position sizes before committing significant capital.
Options trading is generally subject to capital gains tax, though strategies like tax-loss harvesting can help manage liability. A tax advisor can give guidance specific to your situation.
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Sarah Barness is the Head of Content at O.school and freelance writer at Finder, keeping up with the latest products in the industry to present readers with unbiased reviews and guides. She has over eight years of digital media industry experience in fast-paced newsrooms in New York City and Los Angeles. Before Finder, Sarah was ranked as a top-viewed HuffPost editor and writer. She was also a lifestyle senior editor for A Plus, a digital media publication founded by Ashton Kutcher. Sarah holds an MFA in creative nonfiction from The New School, as well as a certificate in editing from Poynter ACES.
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