The easiest way to understand it is forget about the mechanics of how it works and think about what action you take. Just think simple

A stock option is simply a choice: You may buy (or sell) a certain amount stock at a certain price on or before a certain date. Its up to you if you want to do that or not. If you don't do it, the option "expires" and is over.

Lets say I have the option to buy 100 shares at $10 that expires on April 1. The stock price soars to $50. Well, I still have the option to buy that stock at $10 anytime between now and April 1. This is a sweet deal, you'll probably buy it, because its nearly free money.

However, what if the opposite happens. Same situation: I have the option to buy 100 shares at $10 that expires on April 1. But the stock drops to $3 a share. Well, that option now seems like crap, why would I buy it at $10 a share when I could buy it at $3 a share. You likely wouldn't use the option.

Options can be buy or sell, so you can the same scenario, but in a sell, it would be reversed.

I'm keeping it very simple, options are varied and complex and there's a lot going on and there are different types of options, but get the foundation first to understand

The other answers are correct, but I'll try to remove some jargon.

If you own a stock, or a share, then you own part of the company.

If you own a stock option, then you have the option to buy a share at a particular price.

Imagine two scenarios:

• Employee A buys 100 shares in the company, each worth $20 - a total value of $2000. Employee A believes the share price will rise, so he holds onto the shares for 6 months. If he's right, his shares will be worth more than $2000 and he can then sell them if he wants. If he's wrong, they will be worth less than that, and he will lose money.

• Company B issues each of its employees stock options - the option to buy 100 shares in the company, each currently worth $20, for a total price of $2000 in 6 months. 6 months later, Employee B checks the stock price and notices that each share is now worth $30, so he exercises his option, buys the shares for $2000, and immediately sells them for $3000. There is no risk, because if he decides not to exercise his options they cost him nothing.

We can extend the second scenario further:

• Employee C thinks the value of shares in Company B will be $30 in 6 months. He pays Employee B $700, and buys his options from him. Now, Employee B has made $700.

• If Employee C is correct about the price of shares in Company B, he can exercise the options he's bought, and he makes $300 profit. (Buys the shares for $2000, sells them for $3000, but it cost him $700 to buy the options.)

• If the price is only $25, then he still exercises the options, but he's lost money (buys the shares for $2000, sells them for $2500 - but he paid $700 for the option, so he's $200 down).

• If the prices is less than $20, then Employee C doesn't exercise the options, and he's lost $700 - but this is the maximum amount he could lose.

As you can see from these examples, the big advantage of options is that they reduce risk, and this is nearly always why they are used.

You can lose 50% on an option in a day, it’s pretty common. It’s a lot harder to lose 50% on a good stock or index fund in a day. Options go to zero pretty easily.

I’m mostly in index funds and stocks, but I do hold small options positions. Have long calls on MSFT and V, and I have a small amount in SPY puts as a hedge.

Options are powerful and highly leveraged. I don’t recommend putting a huge amount of your portfolio in them, but puts are a great way to profit off things going south that you don’t get with stocks.