In this video/ movie clip, I will introduce the concept of put and call options. Please pay attention to the terminologies such as “buy”, “sell”, “long”, and “short”. Transcript is shown below.

An option is a contract that grants you the right to buy or sell a stock (underlying asset) at a particular price at a specific time/ within a specific period. If it grants you the right to buy, this is a call option. The one who sells the call option is said to be shorting the call or selling the call. And you, who buy the call option, is said to be longing the call or buying the call. Another important feature is that, the one who buys the contract has the right but NOT the obligation to exercise the option. While the one who sells the contract has the obligation to exercise the contract if the buyer wants to! Because of this the buyer has to buy the option by paying a fee – the premium.

So, how would the value of an option depend on the stock price? Assume you bought an option for stock S. And you are allowed to buy the stock at $20 (exercise price X) when the option expired (for example 20 days later). Someone may sell a stock option to you for $4. If you expect the stock is going to rise to $28 at expiration, you maybe willing to purchase the option. Why? It is because at that time, you can buy the stock at $20 according to the contract and sell it for $28 and earn $8 less the premium, which will give you $4 profit. Because of this, the option will have a value of $4 if stock S is $28. So the higher the stock price, the higher the option value. But if the stock price falls below the exercise price plus the premium (breakeven point), you will record a loss. But the loss will be limited to the premium. This is because, as a buyer, you have the right NOT to exercise the contract. So, the floor of the loss is just the premium you paid for the option.

Now for a buyer, the situation is opposite. He/she earns money when the stock price is less the exercise price + premium but his loss is unlimited. You can see the value of shorting a call is just a mirror image of longing a call about the zero. Therefore, this is a zero-sum gain!