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Vanilla options are put or call contracts that give traders the right to buy or sell an underlying asset at a predetermined price before a set expiration date. The most basic type of options contracts, vanilla options follow standard contract terms (e.g., fixed expiration dates and strike prices) and are traded on exchanges like the Chicago Board Options Exchange (CBOE). This is in contrast to exotic options which allow for more customization and are generally traded over-the-counter (OTC) through a broker-dealer network.

Vanilla Option Definition

The term “vanilla options” refers to standard contracts in options trading. They come with fixed features, including expiration dates, strike prices, and contract sizes.

What Are Options Contracts?

Buying an option is purchasing a contract that represents the right, though not the obligation, to buy or sell an underlying security at a fixed price (the strike price) by a specified date (the expiration).

•   The options buyer (or holder) has the right, but not the obligation, to buy or sell the underlying asset (e.g. stock shares) at a certain price by the expiration date of the contract. Buyers pay a premium for each option contract; this is the cost of the option.

•   The options seller (or writer), who is on the opposite side of the trade, has the obligation to fulfill the contract terms, such as selling or buying the underlying asset at the agreed-upon price (i.e. strike price) if the options holder exercises their contract.

What Are Exotic Options?

To understand what makes an exotic option exotic, let’s review a traditional vanilla options contract and how it works.

When trading a traditional option, the owner can buy or sell the underlying security for an agreed-upon price, either before or at the option’s expiration date. The holder is not, however, obligated to exercise the option, hence the name.

An exotic option typically has all of those features, but with complex variations in the times when the option can be exercised, as well as in the ways investors calculate the payoff. For those features, they typically charge a higher price than traditional options. Also, unlike standard vanilla options which are traded on an exchange, exotic options are usually traded in over-the-counter (OTC) markets.


💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

What are the Different Types of Vanilla Options?

There are two types of vanilla options: calls and puts.

Calls

A call option allows an investor to buy 100 shares of an underlying stock or other security at the agreed-upon strike price. A call option gives a buyer a way of profiting from a stock’s price increase without having to purchase the underlying 100 shares. The call buyer only pays a premium per share, which is much lower than the price of the stock.

The profit from a call option is determined by both the premium an investor pays and whether they’re able to exercise the option to buy the underlying asset at the lower strike price. (On the opposite side of the trade, the call writer is obligated to sell the buyer the shares if they decide to exercise.)

A call option buyer can also sell the call option for a premium. By selling the option itself, an investor doesn’t have to take delivery of the underlying shares and may profit from the increasing value of the option.

Note: If the price of the stock falls instead of rises, the maximum loss for the buyer is limited to the cost of the premium paid. However, the potential loss for the option writer can be substantial — theoretically unlimited — since the stock price could continue rising with no cap.

Puts

A put option is essentially the inverse of a call option. Instead of giving the buyer the right to purchase an asset at a fixed price, a put allows the buyer to sell an asset at a fixed price before expiration. Investors may buy puts to try to profit from a stock’s decline, or to hedge against losses on stocks they already own.

For example, if a stock’s price declines before the option’s expiration and falls below the strike price, the buyer can exercise the option, selling the stock for a higher price than the market price. Their profit is reduced by the premium paid for the option.

Protective puts involve purchasing a put option while simultaneously holding shares of the underlying stock. This strategy ensures the investor can sell at a predetermined price even if the stock declines, limiting potential losses. If the stock price rises, they still benefit from the gains, minus the cost of the put premium.

Puts do come with risk. If the stock price rises instead of falls, the put option expires worthless and the buyer’s maximum loss is limited to the premium paid. The put writer, however, faces substantial losses if the stock price plummets.

Recommended: Popular Options Trading Terminology to Know

Characteristics of Vanilla Options

Like all investments, purchasing vanilla options carries a level of risk and volatility. Option buyers risk losing the entire premium paid if the option expires worthless. Call writers risk unlimited losses since stock prices could rise indefinitely, while put writers may be forced to buy the asset at the strike price even if the market price is significantly lower.

Premiums

Whether you are interested in buying a vanilla call or put, you will pay a premium in addition to what you would pay to purchase the stock with the call (should you choose to exercise the option). The premium is nonrefundable, so if you don’t exercise the option, you’ve lost what you paid for the premium.

Volatility

The volatility of an option determines its price. Higher volatility generally results in a higher premium because there is more opportunity for a profit (as well as the risk of loss).

Risk Level

Like most other types of investments, buying options are not without risk. If a stock is lower in price on the market than a call option, the option is worthless. And if a stock has a higher price on the market, the put option won’t net more return on investment.

However, a vanilla option may sometimes be less risky than buying a stock outright for buyers, since the only thing you’re guaranteed to spend is premium. For option writers, however, the risk can be significantly higher. A call writer faces potentially unlimited losses if the stock price keeps rising, while a put writer may be forced to buy the asset at the strike price, even if the market value is significantly lower.

Pros and Cons of Vanilla Options Trading

Options trading is complex and involves risks, but for experienced investors who understand the fundamentals, options can be a useful tool for hedging, income, or straight speculation — as long as you know the risks.

Pros

•   Options trading allows investors to put up a smaller amount of money upfront, which can help minimize potential losses. For buyers, the maximum risk is limited to the premium paid for the option.

•   Selling options allows the writers to collect premiums, although there is the risk of significant losses. (Again, when selling a call option, potential losses can be unlimited if the underlying asset’s price continues to rise with no cap.)

•   Some investors offset risk with options. For instance, buying a put option while also owning the underlying stock allows the options holder to lock in a selling price, for a specified period of time, in case the security declines in value, thereby limiting potential losses.

Cons of Options Trading

•   A key risk in trading options is that losses can be outsized relative to the cost of the contract. When an option is exercised, the seller of the option is obligated to buy or sell the underlying asset, even if the market is moving against them.

•   While premium costs are generally low, they can still add up. The cost of options premiums can eat away at an investor’s profits.

•   Because options expire within a specific time window, there is only a short period of time for an investor’s thesis to play out. Securities, like stocks, do not have expiration dates.

Examples of Vanilla Options

If you’re considering vanilla options as part of your options trading strategy, here are a few examples to illustrate how they work for both calls and puts.

Example of a Vanilla Call Option

A call option allows you to purchase a stock at a certain price within a specified time period. Bullish investors who expect a stock to go up in price typically purchase call options.

For our example, let’s say you’re interested in a stock that trades at $53 per share, and you can buy a call option with a strike price of $55 per share. The premium for the option is $0.15 per share, or $15 total for 100 shares of the stock.

Your breakeven point is the strike price plus the premium. In this case, that would be $55.15. If the stock trades above this price, your option is profitable. Let’s say that, after two weeks, the stock is trading at $59 per share. It is now “in the money” because the market price exceeds the strike price.

At this point, you have two choices. You can either exercise the option and buy the shares at $55 per share (and then sell them at the market price of $59 per share), or you can sell the option contract itself based on its intrinsic value (roughly $4 per share or $400 for the contract, less any transaction costs).

Each approach allows you to realize a profit from the rising stock price without owning it outright until you purchase the call option, if you choose to do so.

Example of a Vanilla Put Option

A put can act as a form of insurance, allowing you to protect against losses if the price of the stock you’re holding falls. It’s also one way that investors might short a stock. Here’s an example.

Let’s say you own 100 shares of a stock that is currently trading at $25 per share. You buy a put option at a premium of $1 per share that expires in two months at a strike price of $30. So in total, you paid $100 for a premium for 100 shares.

In a month, the stock price drops to $18 per share. This is a good time to exercise your put option, selling your 100 shares at the strike price of $30 per share, rather than the market price of $18 per share.

The Takeaway

Vanilla options, which are simply standard puts and calls, can be a way to diversify your investment portfolio and potentially hedge against other losses. While investors are not able to sell options on SoFi’s options trading platform at this time, they can buy call and put options to try to benefit from stock movements or manage risk.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

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