What are options?


Options are derivative contracts that are written between one party who is the buyer, and another who is the seller (also known as the writer).

The buyer of a stock option contract is given the right to buy or sell the underlying stock at the price stipulated in the contract. In order to purchase the option, he or she must pay the writer a premium for it.

On the other side of the option contract, the writer has the obligation to buy or sell the underlying asset if the buyer calls upon him or her to do so (i.e., the buyer “exercises” the option).

A stock option contract specifies the name of the stock it is based on (the underlying), the expiry date of the contract, the strike price, and specifies what type of option it is (call or put).

So, an option contract reads like this:
Underlying security/Expiration date/Strike price/Option type.

Options traded on stock exchanges in North America usually represent 100 shares of the underlying stock. This is why options provide leverage to traders who buy them: by purchasing a single options contract for the price of the premium being asked by the writer, the buyer can control 100 shares of the underlying stock. Used wisely, this is a powerful trading tool.