Option

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What is an 'Option'

An option is a financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).

Call options give the option to buy at certain price, so the buyer would want the stock to go up.

Put options give the option to sell at a certain price, so the buyer would want the stock to go down.

BREAKING DOWN 'Option'

Options are extremely versatile securities that can be used in many different ways. Traders use options to speculate, which is a relatively risky practice, while hedgers use options to reduce the risk of holding an asset.

In terms of speculation, option buyers and writers have conflicting views regarding the outlook on the performance of an underlying security.

For example, because the option writer will need to provide the underlying shares in the event that the stock's market price will exceed the strike, an option writer that sells a call option believes that the underlying stock's price will drop relative to the option's strike price during the life of the option, as that is how he or she will reap maximum profit.

This is exactly the opposite outlook of the option buyer. The buyer believes that the underlying stock will rise, because if this happens, the buyer will be able to acquire the stock for a lower price and then sell it for a profit.

Want to know more about options? Read: Forget The Stop, You've Got Options and Getting Acquainted With Options Trading.

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RELATED FAQS
  1. What is the difference between a banker's acceptance and a post-dated check?

    Learn more about speculation, stocks and options and how speculators use these financial instruments in an attempt to profit ... Read Answer >>
  2. How do speculators profit from options?

    As a quick summary, options are financial derivatives that give their holders the right to buy or sell a specific asset by ... Read Answer >>
  3. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  4. Does the seller (the writer) of an option determine the details of the option contract?

    The quick answer is yes and no. It all depends on where the option is traded. An option contract is an agreement between ... Read Answer >>
  5. How are call options priced?

    Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >>
  6. When is a call option considered to be "in the money"?

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