From Zero to Option Hero
Part I - Back to Basics
Most people who trade options are actually just buying expensive lottery tickets and wondering why they keep losing. And I get it. The first time you see someone on X turn a few thousand dollars into something life-changing on a weekly call, the logic feels obvious. Buy cheap, profit big. Simple leverage play. What could go wrong? Quite a lot, it turns out.
I think the thing that separates options traders from people who dabble in options and lose money is that options aren’t leveraged stocks. They’re completely different instruments that price direction, volatility, time, and path simultaneously. Most retail traders only think about one of those four. The market charges you for all four, every single time, whether you realise it or not. That gap between what you think you’re buying and what you’re actually buying is where most of the losses live.
Before we begin, the three most important (and probably generic) things I’d tell someone just starting out with options:
Your first job is not to make money. It’s to understand what you’re trading.
Cheap options are usually cheap for a reason.
Being right about direction is necessary, but nowhere near sufficient.
Most blow up because they ignore all three. They skip the understanding, buy the cheapest contracts on the chain, and they confuse a directional opinion with an edge. The irony is that options, used correctly, are the most precise and powerful tool in markets. Used incorrectly, and they’re just the fastest way to lose money with conviction.
Let’s call this post the foundation. No full-on Greeks lesson today (that’s Part 2), nor volatility surface mechanics or dealer positioning. There will also be no vanna or charm chatter throughout the whole series, nor will I write the post in emojis. This is just me explaining the core of what an option actually is, how they’re priced, what you’re really paying for when you buy a premium, the different styles and types you’ll encounter, and the structural mistakes most beginners make that are entirely avoidable once you understand the instrument properly.
Same deal as the FX and Equities editions of this series, no textbook fluff. Just how it actually works.
And as always, proceed with coffee.
What An Option Actually Is
Let’s forget every convoluted definition you’ve ever read and strip it back.
An option is a contract where one party pays for a right and the other takes on an obligation in exchange for being paid. A right on one side, an obligation on the other, with a premium changing hands upfront. That’s literally it.
The buyer gets the right, and the seller takes the obligation. The buyer decides whether to act. The seller has no such choice. If the buyer wants to use their right, the seller must honour the contract.
This is genuinely different from buying a stock. Own shares and you’re fully in, unconditionally, riding every tick whether you want to or not. Stock drops 30% while you’re away? That’s your loss, and there’s nothing optional about it. With an option, the buyer has genuine optionality. If exercising the right isn’t profitable, you simply don’t exercise it. You lose the premium and nothing else. Your worst case is fixed before the trade exists.
The closest comparison in everyday life is insurance. You pay a monthly premium, and your insurer takes on the obligation to pay out if something goes wrong. Nothing goes wrong, they keep your premium. Something does, they pay. One side has a right to claim, the other has the obligation to honour it. A put option is, mechanically, insurance against a market decline. The terminology is different. The contract structure is identical.
This is worth knowing as many probably won’t know, but options weren’t originally invented for speculators. They were invented for hedgers. Farmers locking in crop prices before harvest, aiirlines capping fuel costs, fund managers protecting equity books without being forced to sell. The original buyers of options were paying for certainty, exchanging a known, capped cost upfront for protection against an unknown outcome. Traders eventually worked out you could use the same instruments to express views with far more precision than just owning the underlying, and here we are today.
Since I am going from the very basics up in this series, some of you will most likely know most of this post, but some won’t.
Calls and Puts
Everything you’ll ever encounter is built from some combination of these two.
Somehow, the definitions of a call and a put are the two definitions I know like a textbook.
A call gives the buyer the right to purchase an asset at a fixed price before a specific date. You buy calls when you think something is going up. Stock clears your fixed price, you buy cheaper than the market and pocket the difference. Doesn’t happen, and you walk away and lose the premium.
A put gives the buyer the right to sell an asset at a fixed price before a specific date. You buy puts when you think something is going down. Stock falls below your fixed price, you sell above the current market level for a profit. Doesn’t fall that far; you lose the premium.
Calls for the bulls, puts for the bears. Simple starting point.
Rights vs Obligations
Worth spelling out clearly, because the asymmetry between buyer and seller is the most important structural fact in all of options trading.
Buy an option: you have the right to act, no obligation to do anything, maximum loss is the premium paid, and your upside depends on how far the underlying moves in your favour. So the worst case is locked in before you enter.
Sell an option: you have the obligation to perform if the buyer exercises. Maximum gain is the premium you collected. If the underlying moves hard against you, the losses can be large. With a naked short call, in theory, the losses can be unlimited.
This asymmetry is the whole reason options exist as a product. The buyer pays a fixed, known amount for an open-ended right. For a binary event where you have a view but the outcome could go either way, that structure is often far cleaner than holding stock through the uncertainty. A position where your worst case is already defined is a very different psychological experience from one that can just keep going against you.
The Other Side of the Trade
For every buyer there’s a seller. This sounds obvious but most retail traders never really think about it.
When you buy a call, someone is selling it to you. That seller collected the premium and is now obligated to deliver shares at the strike price if you decide to exercise. They’re betting the stock won’t reach the strike, or at least won’t go far enough above it to outweigh the premium they collected. In most cases, that seller is a market maker or dealer, running a hedged book and making money on the spread and the mechanics of delta hedging, not on direction. Sometimes it’s an institution selling covered calls against a long stock position to generate income.
Selling options is a legitimate business. Not a dirty secret. Plenty of institutions and retail investors generate consistent returns selling premium, and it makes complete logical sense: insurance companies make money too. The seller is taking on an obligation in exchange for income, managing the risk of that obligation actively, and repeating the process. It works until volatility explodes and the losses overwhelm the collected premium.
Understanding both sides of the transaction changes how you think about pricing. When you pay $3.00 for a call, someone thought hard about whether $3.00 was enough compensation for the obligation they’re taking on. The price reflects a sophisticated assessment of probability, volatility, time, and risk. When you think the option is cheap, you’re implicitly saying you disagree with that assessment. Sometimes you’re right. However, more often you’re not. Being aware of who is on the other side and why they’re comfortable selling at that price is basic market awareness.
The Basics…
The strike price is the fixed price written into the said contract. For a call it’s the price at which you have the right to buy. For a put, the price at which you have the right to sell. Hold a $150 strike call, and you have the right to purchase the underlying at $150 regardless of where it’s actually trading. The strike is set when the contract is written, and it doesn’t change.
Expiry is the date the option stops being a live instrument. After that, the optionality is gone. If it finishes out of the money, it expires worthless. If it finishes in the money, it is exercised or settled according to the contract rules. Either way, the clock has stopped.
Premium is what you pay, quoted per share. One standard equity option contract covers 100 shares of the underlying, not one share. When you see a call quoted at $3.00, you’re paying $300 per contract. Ten contracts will be $3,000. The per-share price you see quoted and the actual money leaving your account are separated by a factor of 100. Sounds obvious, but I imagine it catches newbies constantly.
Open interest is the total number of outstanding contracts that haven’t been closed or exercised. High open interest at a specific strike means a lot of participants have positions there. This matters for understanding where large hedging flows might exist around expiry, and it’s one of the things professional traders watch when they’re trying to understand where the market might be pinned, which I’ll get into properly in Part 2.
Volume is the number of contracts traded in a session. High volume relative to open interest can signal new positioning being built, or existing positions being closed. Unusual options volume before a major move is something you’ll hear talked about constantly. Please treat it as a signal that deserves investigation, not a guarantee of anything.
Option Styles and Types
Not all options are the same contract. You need to know what you’re dealing with before you trade anything…
American Style vs European Style
Nothing to do with geography. This is about when you can exercise.
An American-style option can be exercised at any point up to and including the expiry date. Single stock options in the US are American style. A European-style option can only be exercised at expiry. Not before. You can still sell the option in the market any time before expiry, but you can’t force early exercise. Despite being an American index, SPX options, which are the most heavily traded index options in the world, are European style. Most OTC options are European style too.
The difference matters most in specific scenarios involving dividends and deep-in-the-money positions. If you’re short an American-style call on a stock paying a large dividend, there’s a real risk the holder exercises early to capture that dividend. If you’re carrying short options into an ex-dividend date without thinking about early exercise, you can find yourself with an unexpected stock position and an unexpected loss.
Cash-Settled vs Physically Delivered
When an in-the-money option expires, something has to happen. Either you receive the actual underlying asset, or you receive a cash payment based on the difference between the settlement value and the strike.
Individual equity options are typically physically delivered. If your Apple $200 call expires in the money, you receive 100 shares of Apple per contract at $200. If you’re short that call and it gets assigned, you have to deliver 100 shares. This obviously has real implications if you haven’t planned for it. Being short options that expire in the money and finding an unexpected stock position in your account the next morning is a very avoidable lesson. Although if you’re just getting started with options, I would not suggest you start selling options straight away.
Index options like SPX are cash-settled. No shares change hands. You receive a cash payment equal to the difference between the strike and the settlement value of the index. Cleaner, no delivery mechanics, no early exercise risk since they’re European style. This is a significant reason why serious options traders gravitate toward index products for anything other than single-stock views.
Exchange-Traded Options
Listed on regulated exchanges, primarily the CBOE for equity and index options. Standardised contract terms, live bid-ask spreads, transparent pricing, accessible through any standard brokerage account. The exchange acts as a counterparty through its clearing house, eliminating counterparty risk.
Weeklies, Monthlies, and LEAPS
The expiry you choose changes the character of the trade completely.
Weeklies expire every Friday. Extremely high theta decay. Very sensitive to near-term catalysts. If you’re positioning around a specific event, an earnings release, a Fed meeting, a CPI print, weeklies give you maximum leverage to that event with a premium that’s relatively cheap in absolute terms. If you’re holding a directional view with no specific catalyst in the next five days, weeklies are working against you almost immediately. Time decay in the final days of a weekly is brutal. You need to be right about direction, timing, and magnitude simultaneously. Three things at once.
Monthlies expire on the third Friday of each month. The liquid backbone of the options market for most names. Tighter spreads, more volume, better fills. Enough time for a thesis to develop without paying for excessive extrinsic value. The rational starting point for most strategies.
LEAPS (Long-term Equity Anticipation Securities) are options with expiries of one year or more. The theta decay relative to the premium paid is much lower than that of shorter-dated options. Delta behaves more like owning the underlying directly. LEAPS are normally how institutional money takes long-term directional positions using options rather than stock. Less capital deployed upfront, defined downside, full participation in a large move over a multi-year timeframe. Deep in the money LEAPS on names with genuine long-term conviction can be a more capital-efficient expression than buying stock outright. Most retail traders never even look at LEAPS because they’re focused on the weekly chain.
0DTE
Zero days to expiry. Options expiring today… What a beautiful invention.
SPX 0DTE now accounts for a remarkable share of daily CBOE volume and has fundamentally changed intraday index trading. The appeal is straightforward: massive gamma, cheap premium in absolute terms, violent moves if you get the direction right within the session.
The math is equally straightforward. To profit on a long 0DTE position, you need to be right about direction, timing within the session, and magnitude, simultaneously. Theta is decaying in real time and most 0DTEs expire worthless. There are many people who trade 0DTE profitably and systematically, running strategies that take advantage of the vol, gamma dynamics and intraday flows. But if you’re still building your understanding of how options behave, treat 0DTE as an advanced instrument that rewards experience.
Intrinsic Value vs Extrinsic Value
Every premium you pay is made up of two distinct components. I’d say that if you confuse them, you’ll spend years being confused by how your positions behave.
Intrinsic value is the real, immediately realisable profit if you exercised the option right now at the current market price. A call with a $100 strike on a stock trading at $115 has $15 of intrinsic value. Exercise it immediately, buy at $100 in a market at $115, that’s $15 per share. A $100 strike put with the stock at $85 has $15 of intrinsic in reverse.
Intrinsic value can’t go negative. The floor is zero. If your $100 call has the stock at $95, the intrinsic value is zero.
Extrinsic value (also called time value) is everything in the premium above that intrinsic figure. It’s what traders pay for possibility: the remaining time until expiry, the uncertainty about where the underlying ends up, and the implied volatility expectations baked into the option’s price. A $100 call with $15 of intrinsic trading at $18? That extra $3 is extrinsic.
So here is the critical mechanical fact about extrinsic value: it decays every single day, without exception. At expiry, it goes to zero. The option is worth only its intrinsic value at that point. No intrinsic value means worthless. A stock can go nowhere for two weeks, and the option holder still loses money just from time passing which isn’t unusual. That’s the product doing exactly what it was designed to do. The decay of extrinsic value is called theta, which I’ll cover in depth in Part 2. For now, just understand: time is not neutral for option buyers. It runs against them every day.
ITM, ATM, OTM
Three states. You’ll use these every time you look at a chain.
In the money (ITM) means the option has intrinsic value right now. A call is ITM when the stock is above the strike. A put is ITM when the stock is below the strike.
At the money (ATM) means the strike is close to where the underlying is trading. No intrinsic value, but the highest uncertainty of any strike on the chain. Nobody knows whether it expires in the money or not. ATM options carry more extrinsic value than any other strike and they’re the most sensitive to everything: moves in the underlying, changes in implied volatility, time passing. Watch ATM options closely, and you’ll learn more about how options actually behave than by reading any number of explanations.
Out of the money (OTM) means no intrinsic value yet. The underlying hasn’t reached the strike. OTM options are cheaper in absolute premium terms, which makes them look appealing, and I’ll get into why that’s often a trap.
Moneyness isn’t fixed as it shifts with every tick. An ATM call becomes ITM if the stock rises, and an OTM put becomes ATM as the stock falls toward the strike. The option’s behaviour, its sensitivity to moves, its time decay, all of it changes as moneyness changes.
How Options Are Actually Priced
This is the section most retail traders never encounter or get to read a simple explanation of. Yet it’s the one that changes how you think about every trade you’ll ever place.
An option’s price is a probability distribution made tradeable.
When you buy a call you’re not just buying the right to purchase stock at a fixed price. You’re paying for the probability-weighted expected value of that right at expiry. The market is effectively asking: given everything we know about this stock’s likely behaviour, what is the expected value of owning this right?
The theoretical pricing framework works roughly like this. Take all the possible prices the stock could reach at expiry. Assign a probability to each outcome. Multiply each outcome by its probability and add them all up. The result is the expected value of the option. The premium you pay is roughly the present value of that expected value, adjusted for interest rates and carrying costs.
So the premium is not arbitrary. It reflects a sophisticated probability calculation. So remember that every time you buy an option, you’re implicitly saying that you think the market is wrong about these probabilities.
There are six key inputs into any standard option pricing model. The current stock price, the strike price, the time to expiry, the risk-free rate, any dividends expected before expiry. And of course, volatility.
Five of those six inputs are either fixed or directly observable in the market. Volatility is the exception. It has to be estimated. And since nobody knows exactly how volatile the stock will be over the life of the option, different traders will have different estimates. The volatility assumption is where all the real disagreement lives, and it’s where professional options traders actually make their money. Not on direction bets but on being right about volatility when the market is wrong.
The volatility figure plugged into a pricing model gives you a theoretical value for the option. The actual market price is determined by supply and demand. When the market price is above the theoretical value based on your volatility estimate, the option is overpriced relative to what you think is fair. Professional traders are constantly running this comparison, asking not just “what does this option cost?” but “relative to what I think vol is going to do/be, is this option cheap or expensive?”
Most retail traders will never ask that second question. They look at the dollar cost of the premium and decide whether it feels cheap or expensive based on their gut feeling about the stock. Whereas a professional is making a far more precise assessment: is implied volatility too rich or too cheap relative to my expectation of how much this stock is actually going to move?
Implied Volatility (Implied Vol)
Implied volatility deserves its own section because it’s probably the most important concept in options trading that surprisingly so many consistently ignore or don’t know enough about.
When people talk about implied vol, they’re talking about the volatility level that, when fed into a pricing model, produces the observed market price for an option. It’s the market’s consensus estimate of how much the underlying will move between now and expiry, expressed as an annualised percentage.
If SPX options are pricing implied volatility at 20%, the market is effectively saying it expects the index to move roughly 20% annualised over that period. A 20% annualised vol on a 30-day option implies a daily move of about 1.25% and a monthly move of roughly 5.8%. These are rough guides, not guarantees, but they give you a sense of what’s baked into the premium.
Implied volatility is not constant across all strikes or all expiry dates. Different strikes at the same expiry trade at different implied volatilities. For most equity indices, OTM puts trade at higher implied volatility than ATM options, which trade at higher implied volatility than OTM calls. This shape is called skew, and it reflects a structural reality: markets normally price downside risk more expensively than upside potential because large down moves tend to happen faster and more violently than large up moves. I’ll go more into depth on this in Part 2.
What you do need to understand right now is that when you buy an option, you’re simultaneously buying direction and buying volatility. The premium you pay reflects both. And if implied volatility is elevated because a catalyst is approaching, like earnings or a Fed meeting, you’re paying an expensive premium that reflects uncertainty the market has already priced in. When that event resolves itself and the uncertainty disappears, implied vol will come off, and that collapse can overwhelm any directional gain you made.
This is what is known as a vol crush. It happens after most scheduled events.. Earnings, Fed meetings, Jobs data, CPI prints. Implied vol spikes into the event, then collapses after it. Buying options into these events means you’re paying peak uncertainty and then watching that premium evaporate even as the stock/index moves your way. I’ll go deeper into event vol and how to think about it in Part 2.
IV rank and IV percentile are the two most commonly used tools for contextualising implied vol. IV rank tells you where current implied vol sits relative to its range over the past year. An IV rank of 80 means implied vol is currently higher than 80% of its readings over the past twelve months. An IV rank of 10 means it’s near the bottom of its historical range. IV percentile is similar but measures what percentage of days in the past year saw implied vol below the current level. Both are imperfect, but give you a quick sense of whether you’re buying or selling premium at an historically elevated or compressed level.
Put-Call Parity: Why a Call Is a Put
Here’s something that so many never learn, and one of the things people don’t fully understand, ever, I don’t think.
Calls and puts on the same underlying, at the same strike, with the same expiry, are mathematically bound together. The relationship is called put-call parity and the punchline is this: a call option combined with enough cash to cover the strike price at expiry is exactly equivalent to a put option combined with owning the stock.
In practical terms, this means you can build a synthetic long call using a long put and long stock. You can build a synthetic long put using a long call and short stock. Every basic options position has a synthetic equivalent, and the two must be priced consistently with each other. If they diverge, there’s an arbitrage, and the market will close it almost instantly.
Why does this matter to me, you ask…
First, it means option prices are not independently set. When the call at a given strike moves, the corresponding put must move in step to maintain parity. Both reflect the same implied vol for that strike. They’re not two separate market views. They’re two expressions of the same probability distribution.
Second, it means you can always find the most efficient way to express your view. If you want to be long a call but the call seems expensive, check whether you could synthetically replicate it more cheaply via a put plus stock.
Third, it will give you an intuition for why dealers run their books the way they do. A dealer who is short calls and a dealer who is short puts at the same strike are, after hedging, managing essentially the same underlying risk expressed in different forms. The flow that results from their hedging affects the underlying stock or index in predictable ways…. This is the foundation of what we’ll cover around dealer gamma in Part 2 and maybe Part 4.
“Cheap” Options Are Usually Expensive Lessons
This one has cost me, and it costs almost everyone.
As I said earlier, OTM options are cheap in absolute dollar terms. It’s easy to see the appeal. But when you buy an OTM option, you’re buying a bet the market has already priced to lose most of the time. This is a fact. The price of that option reflects the market’s probability estimate of it expiring in the money. A call with a delta of 0.20 (and I will explain delta properly in Part 2, honestly, Part 2 of Zero to Stock Hero was better than Part 1… this is becoming a theme) A call with a delta of 0.20 is often used as rough shorthand for something like a 20% probability of finishing in the money. It is not mathematically perfect and it is not a real-world forecast, but it gets the beginner’s point across: the market is not treating that outcome as the base case. Four times out of five, by the market’s own probability assessment, it expires worthless.
The market prices options on what they’re worth in probability-weighted terms. You’re not finding a bargain when you buy a cheap OTM option. You are buying something the market has already priced to fail more often than it succeeds.
For that bet to work in your favour consistently, one of two things needs to be true. Either the market’s probability estimate is wrong (the stock is actually more likely to make that move than the price implies), or your payoff when you win is large enough to compensate for losing four times as often. Both can be true. Very rarely are retail traders buying OTM calls thinking about either of them. They’re looking at the $0.50 premium and imagining it becoming $5.
Then you have to add time to it. The OTM option doesn’t just need a big move, it needs that move to happen before expiry. A weekly OTM call bought on Monday that hasn’t moved by Wednesday has already bled a meaningful chunk of its remaining value just from a few days passing, regardless of what the underlying did. Right about direction, wrong about timing. Still expires worthless…
Cheap in premium is not cheap in probability. Separate those two things and you’ve already eliminated one of the most common and avoidable ways to lose money with this instrument.
The Four Things You’re Actually Trading
Buy a stock and you’re trading one thing, which is direction. Up or down. That’s the only variable. Everything else is noise you ride through.
Buy an option and you’re trading four things simultaneously, whether you realise it or not. Most retail traders are only thinking about one of them. But the market prices all four, every single trade, every day.
Direction. The obvious one. Bullish or bearish on the underlying. Necessary but not sufficient. And critically, you need to be right about direction AND speed. A trader who is right that a stock goes from $100 to $120 eventually makes money regardless of whether it takes two months or two years. An options trader who buys a call expiring in three months and the stock reaches $120 in month four loses money. Right on direction, wrong on timing. The option already expired. Womp womp…
Volatility. Baked into every premium. Buy when implied vol is elevated and you’re paying an expensive premium that reflects expectations of large moves. Buy when implied vol is low and you’re getting in cheaply. You can be completely right about the direction something moves and still lose money because you bought expensive vol that subsequently collapsed. You can also make money even when the underlying barely moves, if you bought options when implied vol was cheap and it subsequently expanded. Vol is a tradeable asset in its own right, completely independent of direction.
Time (theta). Not neutral. It runs against the buyer every day, in one direction only. Longer-dated options give your thesis more room to play out. Shorter-dated options demand precision on timing as well as direction. Every day you hold an option and the underlying doesn’t move in your favour, you’re paying theta. It’s the cost of owning the right. Some days, that cost feels negligible. In the final week before expiry, it can feel enormous.
Path. This one surprises people. Hold a stock through three weeks of choppy sideways action before it finally breaks out on day 22? You’re fine, the stock is at your target. Hold a short-dated call through those same three weeks? Theta has eaten most of your extrinsic value. You got there, but not fast enough, and the option that was worth $3.00 when you bought it might be worth $0.80 by the time the stock finally moves. Direction was correct. Path and timing cost you most of the profit.
Every options trade is a simultaneous bet on all four. The market prices all four, and all four show up in your P&L. Trading options as if they’re just leveraged stock is the single most common and most expensive mistake in options trading.
Payoff Diagrams
You’ll see these in every piece of options education, so here’s what they actually show and, importantly, what they don’t.
A payoff diagram plots the PnL of an options position at expiry against different prices of the underlying. Underlying price along the bottom axis, P&L on the vertical axis. The line tells you what the position is worth when time finally runs out.
Long call: flat line on the left at the level of the premium paid, your maximum loss. Stays flat until the underlying reaches the strike. Above the strike it slopes upward. Breakeven is strike plus premium paid.
Long put: mirror image. Flat line on the right at premium paid. Below the strike the line slopes upward in profit terms. Breakeven is strike minus premium.
Short call: flat line at the top representing the premium collected, your maximum gain. Below the strike you keep everything. Above it, losses rise without a ceiling.
Short put: flat line at the top representing the premium. Above the strike you keep everything. Below it, losses build as the underlying falls.
What payoff diagrams don’t show you is everything that happens before expiry. They’re a snapshot of one moment in time: the last moment. In practice, the option’s value changes every day as the underlying moves, as time bleeds out, as implied vol shifts. The diagram shows you the destination. But says nothing about the journey. And the journey is where you actually live as a position holder. You might be sitting on a large profit at expiry and have experienced a 60% drawdown in the position getting there. The diagram won’t tell you that. Useful for understanding the basic shape of a trade’s risk and reward. Not a complete picture of a live position’s behaviour.
A good site to understand how options behave is optionstrat.com. You can see the payoff profiles in action. Visualise how it will behave across different prices, dates and vol scenarios. Genuinely a useful free tool, especially when you start combining legs.
Why Most Beginners Blow Up Buying OTM Calls
I’ve heard this happen so many times it almost feels scripted at this point.
Someone is bullish on a stock. They look at the chain and see the ATM call at $4.00 ($400 per contract), and say an OTM call two strikes higher at $1.00 ($100 per contract). They buy the OTM call. Smaller outlay, bigger percentage gain if they’re right, feels like better risk-reward on paper.
Little did they think… the OTM call has a lower delta. Thus is less responsive to moves in the underlying. The stock has to travel past the strike before the option generates meaningful intrinsic value. While the ATM call participates in every move from day one and the OTM call just waits for a move large enough to matter. Also, OTM options are more exposed to time decay as a percentage of their value. That $1.00 call is almost entirely extrinsic. All of it is decaying every day. One sideways week and it can lose 50% of its remaining value. The ATM call decays too, but proportionally less of a larger premium.
Oh, and of course, this is the one that really gets people: the $1.00 price makes them buy more contracts. Four OTM contracts at $100 each instead of one ATM at $400. Same total spend, feels like more exposure and more potential upside. What they’ve actually done is multiply their time decay and volatility risk by four. When it goes wrong, it goes wrong four times as hard.
The result: stock moves up 3%, which directionally feels like a win, but the OTM strike hasn’t been reached, theta has eaten most of the remaining extrinsic, and the position is worth less than what was paid despite a correct directional call.
This is the most common options story in retail trading - quiet, grinding erosion of capital in positions that felt smart but were structurally stacked against the buyer from the start.
Exercise and Assignment: What Actually Happens
I assume that most retail traders never think about exercise and assignment until it happens to them unexpectedly. Then I’d guess it’s memorable.
Exercising means using the right you purchased. If you hold an ITM call at expiry, you can exercise it, pay the strike price, and receive 100 shares of the underlying per contract. If you hold an ITM put you can exercise it, deliver 100 shares, and receive the strike price per share.
Assignment is what happens to the seller when the buyer exercises. If you sold a call and the buyer exercises, you get assigned: you must deliver 100 shares at the strike price, regardless of where the stock is trading (if you don’t own the stock - you are now short). If you sold a put and the buyer exercises, you must purchase 100 shares at the strike price, regardless of where the stock is trading. If you don’t own the stock already, you do now.
In practice, most option buyers never exercise their options. They sell them in the market before expiry. The reason is straightforward: when you exercise an ITM option you receive only the intrinsic value. When you sell it in the market you receive the intrinsic value plus whatever extrinsic value remains. Exercising destroys the extrinsic value, whereas selling captures it. So, unless you specifically want to own the shares or there’s a specific reason to exercise early, you’re almost always better off selling the option.
The exception to this is with American-style options in specific circumstances.
Early exercise sometimes makes sense for deep ITM calls when a large dividend is about to be paid. If you hold a deep ITM call and the company is about to pay a dividend large enough that the value of the dividend exceeds the remaining extrinsic value in the option, it can make sense to exercise early to capture the dividend. This is called dividend arbitrage, and it’s why call holders sometimes exercise the night before an ex-dividend date.
Early exercise for deep ITM puts can also make sense when the option is so deep in the money that the remaining extrinsic value is minimal and the interest you could earn on the proceeds of exercising (receiving cash from the strike price) exceeds that remaining extrinsic. Rare in practice but it happens.
The assignment risk for short options is the more important thing to understand for most. If you’ve sold calls or puts that expire in the money, you may be assigned. This can happen at any point for American-style options, not just at expiry. Going into an ex-dividend date with short ITM calls is a particular risk because holders may exercise specifically to capture the dividend.
The Friday Lotto Exception
Now, before someone points out the obvious: yes, I enjoy the occasional Friday lotto.
A tiny 0DTE or weekly option punt risking 5-10bps of NAV is one of life’s simple pleasures. Markets are meant to be taken seriously, but not every trade has to be written up like a pension fund allocation memo.
There is nothing inherently wrong with buying a lottery ticket, as long as you know it is a lottery ticket. A 5bps Friday punt is entertainment with defined downside. In fancier terms, it is a small, pre-budgeted convexity bet. If it expires worthless, who cares?
But when someone takes that same idea and sizes it like a real position, they are outsourcing their dopamine system to the option chain.
What I am trying to say here is that there’s a difference between “I am risking 5bps for a bit of fun” and “I am risking meaningful capital on a short-dated OTM option because I saw a chart on Twitter and think this could squeeze.”
So yes, options can be lottery tickets. But lottery tickets belong in the lottery-ticket bucket. Sized like they are going to zero, because a lot of the time, they are.
When Options Are Actually Useful
Options get a bad reputation because most people encounter them through the speculative side first. Which is not what they were built for.
Defined risk on binary events. Earnings, a regulatory decision, central bank meeting. You have a view but the outcome could go either way, and the stock could gap significantly. Buying an option defines your maximum loss before you enter. You can’t lose more than the premium. For events with real gap risk in either direction, the structure is often far cleaner than holding stock through the uncertainty and hoping.
It’s leverage with a floor. A $200 call on a $100 stock controls $10,000 of notional exposure. Unlike leveraged futures or CFDs, the loss can’t exceed the premium paid. The leverage exists within defined limits. Used properly, it’s a meaningful structural advantage over other leveraged instruments.
Hedging without selling. This is why the instrument was invented as mentioned earlier in the post, and where serious money uses it most rationally. Long a large equity book and worried about a correction? Puts cap your downside without forcing you to liquidate positions you want to hold long-term. The premium is the cost of that protection. Whether it’s worth paying depends on how expensive the protection is relative to the risk you’re trying to manage. More on this in the following volumes…
Income generation through selling. Covered calls against long stock positions. Cash-secured puts on names you’d genuinely want to own at the strike. Structured premium harvesting programmes. In the right volatility environment, with proper sizing and active management, it’s a legitimate income source. However, I would say it’s a full-time job with real tail risk that needs to be managed seriously.
Convexity. Options have non-linear payoffs. A large move in the underlying produces a disproportionately larger gain than a small move would suggest, because gamma accelerates the position in your favour as it moves your way. When you’re long options and the market makes a genuinely large, fast move in your direction, you make significantly more than a linear instrument would give you. For tail risk positions, for macro views where you expect the magnitude of a move to be larger than what the market is pricing, the convexity of long options is genuinely powerful.
Expressing a volatility view. This is something that simply doesn’t exist in stock or futures markets. You can have a view that a stock is going to move a lot without knowing which direction, or that it’s going to move less than the market expects, and express that view directly through options without any directional exposure at all. The ability to trade vol as an asset class independently of direction is one of the things that makes options markets unique.
So if you’ve never traded options… here are a few things worth having internalised before you do.
Know what probability you’re paying for. Every premium is a probability estimate. Cheap OTM options are cheap for a reason. Before buying anything, ask yourself honestly: do I think the market is wrong about that probability? If yes, why specifically? If no, there’s your answer…
Check implied vol before you enter. Is IV elevated versus its own recent history? If yes, you’re buying expensive vol that’s about to be crushed. Is IV near multi-month lows? You might be buying options relatively cheaply. This literally takes you less than a minute, and it changes the analysis completely.
Treat time as a real cost. Every day you hold an option without a favourable move in the underlying, you’re losing money on the extrinsic decay. You can’t buy a call and wait indefinitely for your thesis to eventually play out. There’s no eventually, there’s expiry.
Should be obvious, but I’ll say it anyway… size relative to total capital, not per-contract premium. Twenty OTM calls, because each one costs $100 is not necessarily a small position (this all depends on the size of your book, of course).
Have a plan before entering. Where does the underlying need to go, by when, for this to work? What are you doing if it doesn’t? What are you doing if it gets there faster than expected and implied vol collapses? Options without an active management plan tend to decay quietly into losses. Unless you trade them like me, which is prem paid = max loss in most cases… but we will get to this later in the series, where I will try to share how I trade options and give some examples.
What Comes Next…
Greeks, Implied versus realised vol. IV rank and percentile. Skew and term structure. Event vol and the crush. Expected moves. Why buying calls before earnings is often much harder than it looks. Dealer gamma and how large option positions can create predictable behaviour in the underlying.
Once you understand the Greeks and the vol surface, options stop being confusing and start being a product you can actually read.
Part 3 I plan to delve into spreads, risk reversals, calendars, position sizing, when to buy premium and when to sell, how to manage winners, and so on…
If this was useful, the like button is right there. Restacks help other people find this instead of whatever they’re currently being told on YouTube.
See you in Part 2.
Fed
One thing I had to learn through actual losses: being right about direction is one of the four things you need to get right in options. Most people understand this intellectually when they read it. But almost nobody internalises it before it costs them money. I hope this post shortens that particular curve for some of you.
If you're new here, the Zero to Hero series covers FX and Equities too.
Great article so far, I am still reading. One small quibble. It is very challenging for a retail or self-directed trader to get approval to sell naked options. Absent an institutional résumé, track record, or outsize capital in excess of $1 million it is nigh impossible.
Thank you, very useful!