Five terms you must memorize
- Call — right to BUY at the strike. Bet that underlying goes UP.
- Put — right to SELL at the strike. Bet that underlying goes DOWN.
- Strike — the price you're locking in.
- Premium — what you pay upfront to hold the option (per share, multiplied by 100 for the contract).
- Expiry — the day the option dies. After expiry, worth nothing (if OTM) or intrinsic value (if ITM).
Intrinsic vs extrinsic
- Intrinsic value = max(0, current_price − strike) for a call, or max(0, strike − current_price) for a put.
- Extrinsic value = premium − intrinsic. Pure time value. Decays to zero at expiry.
Worked example
SPY is at $500. You buy a SPY 505 Call expiring in 7 days for premium $3.00.
- Cost: $3.00 × 100 = $300 per contract
- Intrinsic: max(0, 500 − 505) = $0 (currently OTM)
- Extrinsic: $3.00 (all time value)
If SPY rises to $510 by expiry:
- Intrinsic at expiry: max(0, 510 − 505) = $5.00
- Extrinsic: $0 (it's expiration day)
- Option worth $5.00 × 100 = $500 per contract → +$200 profit (+66%)
If SPY stays flat at $500:
- Intrinsic: $0, extrinsic: $0
- Option expires worthless → −$300 total loss (−100%)
The leverage tradeoff
Buying 1 SPY share → linear exposure. Buying 1 SPY call for $300 → same directional bet with 1/166th the capital, but you can lose 100% in a week if you're wrong.
Your task
Compute the P&L on a long call given the inputs.