What Are Options?
Understanding the basics of options contracts and how they work
Introduction
Options are financial contracts that give you the right, but not the obligation, to buy or sell an underlying asset at a specific price within a certain time period. Think of them as insurance policies or reservations for stocks.
Key Point
Unlike stocks, where you own a piece of a company, options give you the right to buy or sell stocks at predetermined prices.
The Two Types of Options
Call Options
- • Give you the RIGHT to buy a stock
- • At a specific price (strike price)
- • Before expiration date
- • You profit if stock price goes UP
Put Options
- • Give you the RIGHT to sell a stock
- • At a specific price (strike price)
- • Before expiration date
- • You profit if stock price goes DOWN
Real-World Example
The Apple Stock Example
Scenario: Apple stock is trading at $150 today.
Call Option: You buy a call option with a $155 strike price expiring in 30 days for $2.
What this means: You have the right to buy Apple stock at $155 anytime in the next 30 days.
If Apple goes to $160: Your option is worth $5 ($160 - $155). You made $3 profit ($5 - $2 cost).
If Apple stays at $150: Your option expires worthless. You lose the $2 you paid.
Key Terms to Remember
Why Trade Options?
Leverage
Control more shares with less money
Limited Risk
You can only lose what you paid for the option
Flexibility
Profit from stocks going up, down, or sideways
Lesson Complete!
Great job! You now understand what options are and how they work. You're ready to learn about the differences between calls and puts in more detail.