Option
IntermediateAn option is a contract that gives its buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a specific date.
There are two basic types. A call option gives the right to buy. A put option gives the right to sell. The set price is called the strike price, and the date the option ends is the expiration date.
The buyer pays a price, called the premium, to the seller for this right. If the market moves in the buyer's favour, they can exercise the option or sell it at a profit. If not, they can let it expire and lose only the premium.
For example, an investor pays 3 for a call option to buy a share at 50. If the share rises to 60, the option lets them buy at 50 and is worth at least 10. If the share stays below 50, the option expires worthless and the investor loses the 3.
The seller of the option receives the premium but takes on the obligation to buy or sell if the buyer exercises.
Options are used to hedge risks, generate income and speculate. Because a small premium can control a large amount of the underlying asset, options can produce large percentage gains or losses.
For worked examples and full lessons, visit notesbysara.org.