An option refers to a security contract that provides a buyer the right to buy or sell an asset at a particular price on or before a date and has strict terms and conditions.
For instance, let us say, you intend to buy a house and have already chosen one. However, you do not have cash now to buy it. An option comes to your rescue in such a situation. You can negotiate with the owner of house and choose the option of buying the house three months later when you are able to generate adequate resources. For such an option, you will however have to pay a price, let us assume $4000 in this case.
An option gives you the right of buying and selling but is not an obligation to accomplish a deal. You can always choose to let the expiry date of the option go, after which the option has no value. If you let the period expire, you let go the entire amount that you invested to book the asset. In the example mentioned above, you let go the entire $ 4000 that you paid to get the option. The underlying assets in most cases are either stock or index funds.
Two Types of Options: Options are classified as ‘calls’ and ‘puts’. ‘Call’ refers to the right of the holder to buy an asset within certain period at a particular price; ‘calls’ have a long position on the stock. ‘Call’ buyers hope that the prices of the stock in which they invested increase rapidly before the expiry of the option.
A ‘put’ is the right of the buyer to sell an asset within certain period at a particular price; ‘puts’ have a short position on the stock. ‘Put’ buyers hope that prices of the stock decreases rapidly before the expiry of the option.
Basic Terminologies: You must know the terms that are used in trading options well, to exercise your right effectively. Following are some important terminologies for your reference:
Strike Price: This refers to the price at which an asset can be bought or sold. A stock must go above this price (for ‘calls’) and below it (for ‘puts’) to determine a position for profit before the option expires.
Listed Option: Such an option is traded on a national options exchange and it represents a hundred shares of a stock. Listed options have fixed strike prices and expiry dates.
In the Money: For ‘calls’, if the share price is above the strike price, then the option is known to be “in the money". For ‘puts’, such a situation occurs when the strike price is below the share price.
Premium: Refers to the total cost of an option, which is determined by factors such as stock and strike prices, volatility of the stock, and remaining time for expiry.
Professional help through online is available for you to trade in options.
Alexander Gordon is a writer for http://www.smallbusinessconsulting.com - The Small Business Consulting Community. Sign-up for the free success steps newsletter and get our booklet valued at $24.95 for free as a special bonus. The newsletter provides daily strategies on starting and significantly growing a business.
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