Option

AAA

DEFINITION of 'Option'

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.

INVESTOPEDIA EXPLAINS '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.

RELATED TERMS
  1. Employee Stock Option - ESO

    A stock option granted to specified employees of a company. ESOs ...
  2. Writer

    The seller of an option who collects the premium payment from ...
  3. Index Option

    A financial derivative that gives the holder the right, but not ...
  4. Option Chain

    A form of quoting options prices through a list of all of the ...
  5. Options Contract

    A contract that allows the holder to buy or sell an underlying ...
  6. Quadruple Witching

    The expiration date of various stock index futures, stock index ...
Related Articles
  1.  if used properly, options can have less risk than an equivalent position in a stock
    Options & Futures

    Reducing Risk With Options

    If you want to use leverage to your advantage, you must know how many contracts to buy.
  2. Options are contracts that give option buyers the right to purchase or sell a security at a predetermined price on or before a specified day.
    Options & Futures

    The Basics Of Option Price

    Options can be an excellent addition to a portfolio. Find out how to get started.
  3. Options & Futures

    Leveraged Investment Showdown

    Margin loans, futures and ETF options can all mean better returns, but which one should you pick?
  4. Options & Futures

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  5. Options & Futures

    Options Trading With The Iron Condor

    This options strategy allows your profits to soar in a sideways market.
  6. Professionals

    Tips For Series 7 Options Questions

    We'll show you how to ace the largest and most difficult section of this exam.
  7. Options & Futures

    The Dangers Of Options Backdating

    This form of executive compensation can pose serious risks for investors.
  8. Options & Futures

    Using Options Instead Of Equity

    Learn how to multiply returns and diversify risk by buying options instead of stock.
  9. Options & Futures

    Options Basics Tutorial

    Discover the world of options, from primary concepts to how options work and why you might use them.
  10. Options & Futures

    Make Better Options Trades With The Average Monthly Range

    We'll show you how to use the average monthly trading range to score better returns.

You May Also Like

Hot Definitions
  1. Santa Claus Rally

    A surge in the price of stocks that often occurs in the week between Christmas and New Year's Day. There are numerous explanations ...
  2. Commodity

    1. A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often ...
  3. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  4. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  5. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  6. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
Trading Center