Say you set aside $200 a month. A call option on Harbor Coffee, our fictional coffee company, is quoted at $4. One standard contract costs $400: two monthly contributions.
Harbor's year 3 closing share price is $66. Suppose it rises to $68 by the call's expiration. You still lose $100.
Being right about the stock's direction is only part of making a profit.
A right with a price and a deadline
An option contract gets its value from an underlying asset, such as Harbor shares. A call option gives you the right to buy those shares at an agreed strike price. A put option gives you the right to sell them at that price. The expiration date is when the right ends.
Our call has a $65 strike, 60 days remaining and a premium, or price, of $4 per share. It follows standard US listed stock-option terms: its contract multiplier is 100, so it covers 100 shares. The option terms and future prices here are invented; calculations ignore dividends, interest, fees and tax.
The premium is $4 × 100 = $400, all of which can be lost. Exercise means using the right: you pay $65 × 100 = $6,500 to buy the shares. The premium buys the right; it does not buy the shares.
The buyer, or holder, pays the premium. Owning a call or put is a long option position. A long put means you own a put; you have not sold the stock short.
The writer receives the premium for opening a short option position. Assignment is the notice to fulfill the contract: sell shares to a call holder or buy them from a put holder at the strike.
What the call pays at expiration
At expiration with Harbor at $68, buying a share for $65 gives you $3 of value. Across 100 shares, that is $300. Subtract the $400 premium and you have a $100 loss. Harbor went up; it just did not go up enough.
That $300 is the gross payoff, or exercise value. Profit is payoff minus premium. Recovering the $4 premium takes a $4 gap above the strike. The expiration break-even, where profit is zero, is $65 + $4 = $69.
At $65 or below, buying for $65 offers no saving over the market price. The payoff is zero and you lose $400. Above $65, the line rises, crossing zero at $69.
For any stock price at expiration:
Here, max means use zero if the difference is negative. At $80, payoff is ($80 − $65) × 100 = $1,500. Profit is $1,500 − $400 = $1,100. At $50 or $62, the call still loses $400.
The fully paid call itself can lose at most $400; its potential profit has no fixed ceiling. Before expiration, a sale uses the option's market price, which may exceed its exercise value. Option pricing explains why.
What the put pays at expiration
A separate example uses a $65 Harbor put with 60 days left and a $3 quote. Its premium is $3 × 100 = $300. You own this put by itself.
At expiration with shares at $50, the right to sell for $65 is worth $15 per share. Payoff is $15 × 100 = $1,500, and profit is $1,500 − $300 = $1,200.
The put's break-even is $65 − $3 = $62. At $62, its $3 payoff per share exactly recovers the premium. Above $62, the put loses money. At $65 or higher, including $69 and $80, the payoff is zero and you lose $300.
The stock has a floor, so the put's profit has a ceiling. At a $0 share price, maximum profit is $65 × 100 − $300 = $6,200. The chart stops at $40, before that limit. Buying a put bounds both gain and loss; a short stock position can lose without limit.
Three ways your position ends
You can sell the right, use it or let it expire. Only exercise turns this option into a stock transaction.
Sell the option to close
Suppose you sell the call for $2 per share before expiration. You receive $2 × 100 = $200. Subtract the $400 you paid and the loss is $200. No shares need to change hands.
A closing sale ends your long position without making you a writer. The contract can remain open in another holder's hands. The sale must match the option you own: underlying, call or put, strike and expiration. As with other orders, you may not find a buyer at your price.
Exercise the right
Exercising the call means paying $6,500 for 100 Harbor shares. The $400 premium is already spent. With Harbor at $68, those shares are worth $6,800: $300 more than the exercise payment, but $100 less than your total $6,900 outlay.
These stock options settle in shares; the chart's payoff is not a cash payout. If you keep the shares after exercising the call, their later losses can exceed the $400 option premium.
Exercising the put means delivering 100 shares for $6,500. Without shares to deliver, exercise can create a short stock position if your broker permits it. That position also has risks beyond the put's $300 premium.
Let the right expire
Suppose Harbor ends at $60 and the call expires unexercised. Buying at $65 offers no benefit, so the $400 premium is lost. In a separate ending, the put expires unexercised at $65 or higher and loses its $300 premium.
A loss does not prevent exercise. At $68, the call still has $300 of exercise value despite your $100 loss. For US equity options, an expiring option with exercise value can be exercised without new instructions from you. OCC, the clearinghouse, calls this exercise by exception.
Your broker sets customer procedures, can submit contrary instructions and may need your instructions earlier than the exchange deadline. Doing nothing can leave you owning or owing shares.
Two monthly contributions buy this right. They do not fund the $6,500 share purchase if it is exercised. Understanding an option does not require buying one.
In short
- Calls give a right to buy; puts give a right to sell.
- A $4 standard equity-option quote means a $400 premium, all of which can be lost.
- Profit subtracts premium: this $65 call needs $69 to break even at expiration; the put needs $62.
- Selling to close ends your option holding. Exercise buys or sells shares. Unexercised expiration ends the right.
- Even a losing option can be exercised, creating a stock position with its own costs and risks.