Navigation skipped

Options Trading Example: Exploring Real Trade Scenarios

Options trading can get complex, so it helps to explore tangible examples that break down key concepts clearly.

Updated

8 min. read

- Options trading involves buying and selling contracts that provide the right to trade an underlying security.
- When you own call options, you benefit when the underlying asset’s price rises beyond a certain level, whereas put options benefit from drops.
- Depending on if the underlying asset’s price rises, stagnates, or drops, your option contract can become in the money (ITM), out of the money (OTM), or at the money (ATM).

There are dozens of options trading strategies you can explore, but as a beginner investor, it can be difficult to conceptualize the possible outcomes of any given approach.

With that in mind, let’s go over a couple of examples to better understand stock options and what to expect when they’re part of your portfolio. We’ll focus on buying calls and puts to break down their relationship and illustrate why you might choose one over the other.

Options trading example 1: Purchasing a call option

Looking at buying a call option is perhaps the clearest way to understand the relationship between an option and its underlying asset (in this case a stock, as the two tend to move in the same direction. A call option gives you the right to buy the stock at an agreed-upon “strike price” regardless of what it’s currently trading at. So, as it climbs further above that threshold, your potential profit grows.

Imagine Stock XYZ is currently trading at $50 per share. You have a bullish outlook, meaning you believe the price will increase, so you purchase a call option with the following terms:

Strike price: $55
Premium: $2/share (total cost: $200, as one contract represents 100 shares)
Expiration: 30 days until expiry

Let’s look at some possible scenarios from here.

Scenario 1: Stock price rises to $65

Since the underlying price of the share ($65) is greater than the contract’s strike price ($55) before its expiry, your call option is in the money (ITM).

Note that in this example, your break-even point is when the shares cost $57 ($55 strike price + $2 premium), so any movement above that is profit. Below that, you’re still at a loss even if the option is in the money.

At $65 per share, you’re well above that threshold, so you have two scenarios to consider here:

A) Sell the option contract

The value of the contract will have increased since the right to purchase shares of Stock XYZ for $55 per share when it’s trading at $65 is valuable. So, you might choose to simply sell the option contract. Let’s say the option is now priced at $10 on the market. Your overall profit would be $800 (less trading commissions).

Here’s how that’s calculated:

Initial cost of option contract = $2 premium x 100 shares = $200
Total sale value of option contract = $10 premium x 100 shares = $1,000
Net profit = $1,000 - $200 = $800 (less commissions)

B) Exercise the option contract

If you exercise the option, you will be obligated to buy 100 shares of Stock XYZ at the $55 strike price. You could then continue to hold the 100 shares of Stock XYZ if you think they’ll keep growing, or you could sell them at the current market price of $65 per share to lock in your profit. If you chose to sell right away, your total profit would also be $800 (less trading commissions).

Here’s that calculation:

Initial cost of option contract = $2 premium x 100 shares = $200
Cost of exercising option to buy Stock XYZ at strike price = $55 x 100 shares = $5,500
Proceeds from selling Stock XYZ at market price = $65 x 100 shares = $6,500
Net profit = $6,500 - $5,500 - $200 = $800

Here’s the corresponding break-even graph for this call option scenario:

Diagram showing how a call option works

Scenario 2: Stock price stagnates at $50

If Stock XYZ remains at $50 by the expiration date, the option is considered out of the money (OTM) as its strike price is higher than the underlying price. If the stock price were to climb slightly and equal the strike price exactly, the option would be considered at the money (ATM) but would still have no intrinsic value (though it may still hold some time value before expiration). In either case, you could let the option expire, and your total loss would be limited to the premium paid ($200). Alternatively, you can attempt to sell the option contract before expiry to reduce your loss.

Scenario 3: Stock price falls to $30

If Stock XYZ’s price drops to $30, the option remains out of the money. Your total loss is still limited to the premium of $200, avoiding the deeper losses that direct stock ownership might incur. You still have the ability to sell the option contract before expiry to reduce your loss, though its value will have eroded as it moves further out of the money.

Options trading example 2: Purchasing a put option

Let’s stick with our example of Stock XYZ trading at $50 per share, except this time, you have a bearish outlook for the stock, meaning you’re expecting the price to fall.

Enter the put option, which gives you the right to sell the stock at a set strike price. As the mirror opposite of a call, a put can be used to profit from a stock price decline, or to hedge against losses if you also own shares of the underlying stock.

Since you’re expecting the price to drop, let’s say you buy a put option with these terms:

Strike price: $45
Premium: $2/share ($200 total)
Expiration: 30 days until expiry

Note how the only difference here is that the strike price is lower than the market price, whereas the call option’s strike price was higher.