Options (Calls and Puts)

The contract, in plain terms

An option is a derivative: its value comes entirely from the stock underneath it. One standard contract covers 100 shares and spells out three things: a strike price, an expiry date, and whether the holder may buy (a call) or sell (a put) at that strike. The buyer pays a premium for that right and can walk away if exercising ever stops making sense; the seller pockets the premium and takes on the matching obligation.

That word "right, not obligation" is the whole invention. A call buyer profits if the stock climbs well above the strike; a put buyer profits if it falls well below. In either case, the most the buyer can ever lose is the premium paid.

The four basic positions

Every options strategy, however exotic its name, is assembled from four building blocks:

What the premium is made of

A premium has two layers. Intrinsic value is what the option would be worth if exercised right now: a $55 call on a $60 stock has $5 of it. Everything above that is time value, the price of possibility, and it grows with the time left and with how wildly the stock tends to move. Time value melts away as expiry approaches, faster and faster near the end. That decay is the quiet tax on every option buyer and the steady friend of every option seller, who gets paid for letting the clock run.

Protective puts: insurance you can price

The first respectable household use is the protective put: you own shares, you buy a put on them, and you have set a floor under your position for the life of the contract. If the stock collapses, the put's gains offset the shares' losses below the strike. It works exactly like an insurance policy, premium included, and like insurance it costs real money that is usually "wasted" in the good years. Buying puts routinely is a meaningful drag on returns; buying one around a specific, dated worry is a defensible expense.

Covered calls: income with a catch

The second respectable use is the covered call: you own 100 shares and sell a call against them. The premium lands in your account immediately, and if the stock stays below the strike, you keep both the shares and the money. The catch shows up when the stock surges: your shares get called away at the strike, and the rally beyond it belongs to someone else. A covered call converts uncertain future upside into certain present income.

Canada has packaged this trade at industrial scale: covered-call ETFs sell calls across a whole portfolio and pay out the premiums as unusually high distributions. The honest framing is that those distributions are not free yield; they are partly your own upside, sold in advance. Such funds tend to lag their plain counterparts in strong bull markets and cushion modestly in flat ones. Fine as a deliberate income choice, misleading as a "higher-yield version of the same fund".

The honest warning

Options are the sharpest tool most brokerages will hand a retail investor, and the statistics are unsentimental: most purchased options expire worthless. The leverage that turns a small premium into a large gain works identically in reverse, and a position that needs the stock to move the right way, by enough, before a deadline, loses to the calendar more often than to the analysis. Selling uncovered calls is more dangerous still, with losses that are theoretically unlimited.

This is why brokerages impose approval levels: buying options and writing covered calls sit at the accessible end, while uncovered writing requires the highest clearance and substantial margin. The levels are not bureaucracy; they are a map of how quickly each strategy can hurt you.

A word on tax

For most investors who trade occasionally, option gains and losses are generally capital in nature, taxed like other capital gains, though frequent or business-like trading can push results into fully taxable income, and the rules for sold options have their own timing wrinkles. Active traders should get professional advice. In registered accounts, the menu is narrower: buying calls and puts and writing covered calls are generally permitted, while naked writing is not, so the riskiest strategies stay outside tax shelters by design.